Season 4, Episode 1: Financing the energy transition

Lorraine Johnston:
Hello and welcome to ESG Matters at Ashurst Perkins Coie. I'm Lorraine Johnston, partner specializing in financial regulation. And you're listening to season four of Game Changers, from innovators at the cutting edge of technology to impact investors funding a cleaner energy future.

Each and every one of our guests is changing the game in their field. In today's episode, you'll hear our conversation with Sahar Shamsi, partner and leader of energy and climate economics teams at Oxera, a consultancy that advises companies, policymakers, regulators, and lawyers on any economic issue connected with competition, finance, or regulation. With almost 18 years at Oxera, Sahar is an expert in financial economics, with a focus on decarbonization and the economic regulation of utilities.

Today, we are talking about investor priorities in the low carbon economy. So, let's jump into the discussion. Sahar, welcome to the podcast.

Sahar Shamsi:
Thank you, Lorraine. Lovely to be here.

Lorraine Johnston:
So, you have become a recognized expert on finance and competition issues for the energy sector. Is this always the game plan? Or has your career taken a series of turns?

Sahar Shamsi:
I'd love to say that there was a masterful game plan and that I knew everything ex ante, but I didn't. There wasn't. I didn't know that my career would end up at this exact point. So, my training was as a financial economist at Oxford and later at the LSC. And I joined Oxera as an analyst nearly 18 years ago, as you said. So, I've been here a while. And I had done a few internships in government banking in the UN.

So, I had some idea of what I liked and didn't like in terms of my working life, but really it was the Oxera culture, this combination of academic rigor and the problems we solve, all of these real-world constantly changing dynamic problems that kept me interested and kept me here. So, over the years, I've specialized in energy and then we set up the climate practice five years ago. And I have found it constantly interesting and topical to work on these issues. I'm obviously biased, but I do think that energy and climate are some of the most interesting and important career areas to work in at this point in time because of just how existential the challenge of the climate transition is appearing to be. So, I guess no masterful game plan, but really happy and content to be here.

Lorraine Johnston:
Very good road to where you are. Oxera prides itself on its cross-sector depth, but how does that strengthen translate for your clients and the way that they look and formulate their sustainability in practice?

Sahar Shamsi:
It's a really good question and one that I've reflected on a lot as I've thought about the different work that I do with the different clients. And I mentioned that I co-lead two different teams, energy and climate in Oxera. And that separation reflects deliberately that while the energy industry has been at the coalface of the climate transition, that's an overused pun, coalface of the climate transition for energy, but let's go with it. It's the issues of climate ESG sustainability that are not just energy. They're often either inherently cross-sectoral or they spill over from energy into other industries.
To put that in context, when we look at the IFRS ISSB, so the International Sustainability Standards, which voluntarily companies can choose to disclose against, those cover 11 sectors and 77 industries. It goes well beyond energy into other sectors that Oxera works in. So, infrastructure, transport, telecoms, financials, tech, healthcare, there's a whole range of sectors and industries that are covered by sustainability reporting.

And I find that the privilege, as well as the challenge of being a consultant, is that you will never know as much about an organization and its operations and its strategy, including the sustainability aspects as the organization itself knows. So, the value that you add has to be by a breadth of expertise that enables you to add something that they don't know, that allows you to understand their problem, to identify and reassure that they're not unique in facing the problems that they're facing, and then drawing on that expertise from other sectors and geographies and even disciplines within economics and finance to advise on their challenges.

I thought an example that I could share with you, is a report that my team and I wrote which we presented to the European Commission. And it was about the challenges of low carbon steel, so green steel and green cement, in terms of these being very important sectors within industrial manufacturing, very hard to abate. And there are technologies which are decarbonizing the production of steel and cement, but the uptake for them, especially when the costs are higher, are slow. So, could we come up with a market solution which allowed for the decoupling of the physical attributes of the steel and cement and its supply so that we could kickstart the uptake of green steel and green cement?

Now, that sounds like a lot of words. It sounds very complex. It isn't. We drew on energy, digital, and financial services knowledge to develop proposals for book and claim systems based on environmental attribute certificates, so, a bit like green energy, to basically bring together as wide a demand as possible without it being limited to the places where you could physically buy and transport at low cost the green steel and green cement. So, even if you're sitting in Japan, you can book the demand for green steel and pay less than you would have to if it was transported all the way to Japan in terms of maybe the non-decarbonized or the normal steel and cement is supplied in the local area where the production is happening, but the demand has been aggregated from around the world through these virtual chain of custody models.

And that's a kind of idea that doesn't come if you just sit thinking about my energy experience or the economics of steel production. It's about market design. And we have found that these different clients working with challenges that are as complex and multidisciplinary as the climate transition demand the same from us in terms of diversity of skill.

Lorraine Johnston:
That sounds like a fascinating read and a fascinating process to reach the final report. Would it be safe to say then that, perhaps, the pathway to decarbonization might be simpler than we think?

Sahar Shamsi:
Mm-hmm. That question provokes me to mischief because it's like, why let things be simple when with just a bit more thought we humans can make everything more complex? But no, let's engage seriously. Decarbonization itself, I wouldn't say, is simple. It's complex. It's multidisciplinary. It's financial, technical, behavioral, policy alignment. A lot of things need to happen for a pathway to decarbonization to be effective.

But I would assert based on my experience that the building blocks of any path to decarbonization are simple. It helps to break what looks like an intractable problem to its component parts. And I find that in the intractable problem of a decarbonization or transition pathway, most of the problems that clients face can be broken into four parts. It's about the availability of the technology, about the availability of the finance on terms that would enable the risk-adjusted returns that are required by investors to be met. It's about stakeholder buy-in and it's about the policy environment. Is it helpful if I expand on each of these, Lorraine?

Lorraine Johnston:
I think it would, yes.

Sahar Shamsi:
Let me spend a little bit of time on my blocks then. The first one is technology. We ask ourselves, and this is not the role of the economists, but often you'll be working with firms that have engineering expertise themselves or have engineers working with them. And the question you're asking there is, does the technology for decarbonization with the green tech exist? Is it feasible from an engineering perspective to deliver primary decarbonization of, for example, an industrial process?

And this is where the language I was using before about green steel cement being hard to abate areas that the language of hard to abate comes into its own when you're thinking about, "Can I actually decarbonize this primary industrial process?" or, "Does it need more engineering and technical feasibility work before it can scale?"

But let's imagine that it's there, the engineering and technical feasibility works. And now, we're thinking about how do we scale this? How do we get uptake? How do we roll it out? And there the role of finance comes in. So, with finance, and this is where I spend a lot of my time as a financial economist, the question you're asking fundamentally, what investors need is sufficient risk-adjusted returns. And that means either the risk needs to be lower or the return needs to be higher if you are not getting entry into an uptake of a particular product or solution.

So, some of the examples of work that we've done in this space have been in energy transition assets, like, what return do carbon capture network investors need to make the investment worthwhile? Or how could the risks of a hydrogen network or of a new utility scale nuclear investment be managed, including by the policy environment? Because I'll come to that in a minute, but that plays a very pivotal role in this calibration of the adequacy of the risk-adjusted return.

I've read lots of reports, new numbers come out every year about the extent to which debt and equity capital for green investments is available in Europe, but that it's not being fully deployed. And the answer given by researchers looking at this is often that transition projects don't yet offer the risk-adjusted returns or the investment structures that are needed by institutional investors to be able to scale. So, there remains this significant and persistent gap between the available capital and the investible opportunities, particularly when we're talking about first of a kind or higher risk decarbonization projects.

Lorraine Johnston:
So, that's super interesting from the financial economic side. I guess, looking externally, what are some of the behavioral factors that might have an effect on the actions of companies or corporates in this area?

Sahar Shamsi:
So, in many ways, this is a category that speaks for itself. It changes hard. But for green tech to be deployed, it needs to be accepted along the industry value chain. So, suppliers, customers, peers, producers, everybody needs to be able to move along the same chain for a decarbonization pathway to be achieved.

I've been working for many years in different angles and perspectives on issues of the hydrogen value chain. And one of the things that I find really interesting to think about in that context is how many things need to happen for a hydrogen value chain to be built. Because you need production in the first place, the electrolyzer technology, the excess renewables power for the production of the green hydrogen. Those are non-trivial aspects of scaling up that production in the first place. But let's imagine you built it and you had that production capability. You still need a network to transport it. The pipeline infrastructure needs to be in place. Or if you're thinking about marine, you need to do a lot of changes in the context of the current gas transport infrastructures that are available by marine. And then you also need... Let's imagine you produced it, you transported it, but you also need users to have the engines and boilers that are hydrogen compatible.

So, you can see, it's not... when we talk about the investor priorities and the shift of the low carbon economy, we're not talking about a single investor or a single investment decision. It's this whole chain of the producer, the transporter, the user, all of them need to have the right incentives and for their needs for the risk-adjusted return adequacy to be met.

And then that finally brings me to that wrapper of policy and regulation. Because as I said, that's such an important lever in terms of, if you need to bring the risks down or the returns up, the role of regulation and policymaking is so important in de-risking the investment, but also to tweaking the return. Policy can take the form of standards and requirements, but it can also take the form of incentives like taxation or subsidies that are more favorable. So, with each of these problems, that wrapper of reg and policy can help in unblocking the barriers to decarbonization in that first ideas and technology stage, that access to finance and capital adequacy stage, as well as the stakeholder acceptance stage along the value chain.

Lorraine Johnston:
That was a fantastic summary of what I know is an incredibly complicated intersection of different drivers and levers in this area. Thank you for that.

Sahar Shamsi:
It's a pleasure. It's been many years we're working on this.

Lorraine Johnston:
And that's the thing, isn't it? You can hear that. You can hear exactly the thinking and not just the hours and the days and the weeks of thinking that's gone into this in order to be able to present that so concisely and so clearly as well. I guess, however, from your clients, our clients, but company perspective, how do you think that they need to look at some of these considerations? How do you think that they need to adjust their strategy, not just in terms of economic conditions, which arguably might fall into that last buckle around about those policy drivers or incentives or changes, one may say, but at the same time, so looking at that sort of external aspect, but also thinking about their own investors, their own clients or whoever that might be, how do you think that they need to be thinking about some of these issues that you've set out so clearly?

Sahar Shamsi:
To answer that in a fulsome manner, I would need to tell you more about the different types of investors that we see in different settings. So, in my work in ESG climate sustainability at Oxera, we see three main areas of work. One area is in regulation and policy design. So, the questions you face there are things like, I don't know, how should negative emission technologies be incorporated into the emissions trading scheme? Or how should new carbon capture networks be regulated?

Second area is transactions. So, how do you value ESG risk in a regulated due diligence? Or how do you analyze the sustainability impact of a merger as part of merger control proceedings? And the third is litigation support. So, giving expert evidence in a transition-related dispute, for example, or a renewables dispute. These are three distinct buckets of work in which you see investors in different settings. So, that market design phase, that transactions phase, and that litigation phase.

Returning then to the question of how companies meet investor needs with respect to sustainability objectives and sustainability reporting, I would always say at the outset, as a wrapper, that investors look for decision-useful information. When we talk about the sustainability reporting standards of either the ISSB or the European CSRD, you'll have to forgive the alphabet soup of acronyms at that point, or indeed things that are developing now, the UK is looking at the SRS, always when you read through the long texts at a company, the guidance that comes with sustainability reporting standards, there will be a raison d'être expressed of we need to produce decision useful information. These are supposed to act as a compliment to what we're used to as financial statements that give you an idea of value and costs and risks.

And I think that that's the journey that we're going on in terms of the maturation of ESG from an investor ask perspective. Because in a market design question, the investor priority is usually to get the risk-adjusted return right such that capital can be deployed. In a transaction, the investor priority is to understand that ESG-related value impact to be able to price this in a transaction or to disclose it compellingly in a merger control proceeding to the competition authority. And in litigation, the investor priority is also related to understanding that value impact of ESG.

Because while you're trying to get to a good legal outcome on a transition-related dispute or a renewables dispute, what you're using are tools that look at value impact. So, you're looking at the quantification of the harm in an alleged breach of a net-zero transition commitment or a greenwashing dispute or a renewables dispute. So, they're quite distinct settings, but the common denominators are that any sustainability-related objective or reporting requires investors to be receiving that understanding of the impact of that ESG initiative or their ESG policies on the value that is generated or that is lost.

And I find that this is still an area that is in flux as an economist when I'm asked, "Can you please review these sustainability reports that we've produced?" Often, you'll get a long list of factors that the management of the firm or their auditors have identified as value drivers and risks associated with ESG. But it stops there. It stops at that production of the list of value drivers and risk factors. But then you ask yourself, "Okay, I've identified that I have risks in relation to carbon pricing or in relation to the circular economy and waste management or in relation to my energy dependence. But can I go a little bit further to say, here's exactly how it translates into a revenue impact? Is it enduring or not? Is it unique to me or is it a market-wide factor? Here's how it translates into a cost factor. Again, is it enduring? Is it OpEx? Is it CapEx? Is it insurable? What's the path to remediating this cost that I'm facing?"

And then risks. And risks affect, going back to what I was saying, the risk-adjusted return requirement. The higher the risk you're taking on, the higher the return that you would require would be. So, it's all interlinked, but I think that's the journey we're on. Investors are asking for decision-useful information in all of these different settings in regulation, in transactions, in litigation. But when I link this back to sustainability reporting, the journey we're on is it's not just about identifying the ESG value drivers and opportunities and risks. It's also about being able to evidence that and qualify it so that you can wrap your arms around it and really manage it as opposed to observing it.

Lorraine Johnston:
Do you have any examples, not necessarily naming names, of companies that you think may be a leader in this who've shown or expressed a clear achievable sustainability plan and able to get that balance right between what investors need and what they can produce?

Sahar Shamsi:
It's a really interesting question because I think rather than thinking about a company, I might tell you about a little economy. So, for many years, Oxera, myself, my teams have worked with the states of Jersey. And we have worked in Jersey mostly with the government over a number of years on the design, as well as the implementation measures of their carbon-neutral strategy. So, I'm not thinking in terms of your question there, Lorraine, that, is it perfect? Is it getting absolutely every balance right at every point in time? It isn't, it's complicated. But what I've enjoyed about the states of Jersey's carbon-neutral strategy is, at the outset, they were quite ambitious. They set quite ambitious emissions reduction targets, and then they were quite systematic about it.
So, we really looked at, where do emissions arise in the context of the Jersey-specific context? Because most economies, a big challenge, as you'll know, Lorraine, is the decarbonization of power of the energy that is consumed. But that wasn't an issue in Jersey. They had a lot of interconnected power from France. France has a lot of nuclear. They were paying for the green energy certificates that enabled them to access that decarbonized power from France. So, at the outset, it's, if we can electrify more of the economy to the extent that we face the constraints around how much power we can import and ply within the economy, then that seems like a ready first pathway to decarbonization. But then we really examined the sources of emissions in the two areas that were their big drivers. So, that was in heating and in transport.

And so, really thinking about, "Okay, how do we be modeled at one point on a house-by-house basis how the stock of housing in Jersey would need to be decarbonized," what that meant for the level of insulation that needed to be installed and the heat pumps that needed to be installed and whether enough suppliers would be available and how you make it happen. And then after we had done all of the sectoral emissions projection and modeling, we asked ourselves the questions again. So, the government wasn't too blinkered about, "Oh, we've come up with a pathway, let's just stick with it. We're going to electrify everything." They kept asking, "Could we use biogas more? Could we use hydrogen more? Is there some unicorn fuel out there that we just haven't thought about?"
So, I liked specificity, I liked the pragmatism, and I liked the systematic nature of the sustainability plans that the government was developing. No plan is ever perfect, but it stays in my mind as one example of thinking with humility as we have imperfect information at any point in time, but thinking what's the best that we can do for the economy?

Lorraine Johnston:
It sounds as if, in that particular example, it was a very positive experience, but there's also an openness to not quite have a blank sheet of paper, but to explore not all possible options, but certainly, many possible options in order to get to the right conclusion. I guess the states of Jersey is a little bit different because you don't necessarily have as much of an influence of investors as, say, a private company or some of our private capital funds might do. I guess you mentioned that you work with a lot of different types of investors and you have your own classification of some of the different investors that are out there in the market. Taking maybe a couple of examples, what can you say are the key considerations for different types of investors in that shift to a low carbon economy, both in the short-term and in the longer-term pathway?

Sahar Shamsi:
I think that the thing that's probably not come up so far in this conversation is what I often see as the timing of an investment challenge where you are getting stuck on, "Do I commit this capital to this type of technology or to this pathway of a set of technological options?" Because with decarbonization, one of the more naughty problems that we're facing, Lorraine, is that there is so much path dependency, number one. And there's also a lot of network effects, number two. So, it's not just that you need to be using the technology, it's that others need to be using the technology in order for it to scale.

And I'm thinking again about the example of the hydrogen value chain as one example of a network, but it's also in other ones like a lot of industrial processes talk about carbon capture as a means of decarbonizing. Carbon capture requires a whole set of interrelated infrastructure to be built and there are path dependencies about who goes first. Does the company that is going to be looking at carbon capture as an element of its decarbonization go ahead and fit industrial carbon capture solutions to its manufacturing plants?

Well, how can they have the certainty of doing so even with subsidies being available, which is often the case in terms of a lot of European markets at present? But how can they have the certainty of doing so if they don't know, number one, that other competitors will do the same and therefore they might just be loading on a cost onto themselves that will not prove to be an industry norm and that makes it harder for them to compete?

And number two, they might not have confidence that the infrastructure that's available to cart away that carbon that they've captured in terms of the carbon captured transport and storage networks will be built. And at the same time, those transport and storage networks where we've also been doing work and due diligence for different investors are at their own stage of uncertainty about exactly how will some of the risks around carbon leakage be managed? How will they get the scale in terms of both gaseous and liquefied carbon being transported to be able to build the infrastructure that isn't in a way inefficient or redundant because they're trying to duplicate the networks that different companies are building?

Whereas, actually, it would be more efficient if they built it together and then used that common infrastructure to reduce some of the costs that they're facing. That was one of the cases we worked on with Shell and Total. Again, it's in the public domain in the Netherlands about, instead of looking to compete with each other in the provision of carbon capture and transport networks, they should jointly market, jointly price, jointly build those assets to try to manage the costs.

But I guess what I'm trying to share is that there has been a lot of concerns about, when do I go and how do I go? Am I going to be going alone? Am I waiting for path-dependent investments that would ideally have happened first to have already happened? And how can I make sure that what I'm doing is in a system going to make sense where there's network effects to bringing costs down?
And again, investors across Europe, especially equity investors in energy transition assets are facing this challenge, but the solutions they're looking for are often from the policy and regulatory environment. So, there's a lot of conversations with the governments of different European markets that we work in and with regulators on behalf of investors to try to understand, how can we de-risk or redistribute or co-invest? How can we share some of these risks so that we can get that calibration, the right risk adjusted return? Either the risks come down or they're distributed in a way that is palatable or the returns in some way are managed up. The killer of it is when you have an investor saying, "I can't do it. I can't take a 10% risk for a 5% return."

Lorraine Johnston:
So listen, that has been incredibly insightful and we've delved into a lot of different topics. I appreciate we probably only scratched the surface from your perspective, but actually from my perspective, there's been some real insight and some depth into our conversation. I guess, just to lead us out, is there anything from the bigger picture that you think is worth bearing in mind for anyone listening or anyone that's working in this area that can, perhaps, just give us the context that we need to keep looking and keep pursuing some of these issues?

Sahar Shamsi:
Thank you so much, Lorraine. I really enjoyed that conversation. I think I might end this where I began it in terms of my interest in economics and the power of economics, because when I was probably 13, the first line in my first economics textbook, which I think I'll share here, was, economics is the allocation of scarce resources to meet unlimited wants. And I loved that. It resonated as a teenager about my own budget constraints about unlimited wants and allocation of scarce resources to meet those wants.

But I think about that often when I'm thinking about the climate challenge and the energy transition, because again, it's an issue of the allocation of scarce resources to meet unlimited wants and unlimited investment opportunities. Where are our scarce resources best allocated? And I feel really hopeful that the toolkits that we have in economics and finance are there to tackle those building blocks of decarbonization barriers that we talked about, the challenges around technology scaling of finance in terms of adequate risk-adjusted returns being available, stakeholder acceptance along the value chain, that wrapper of regulation and policy as a enabler and facilitator of all of this. It's complicated, but it's not complex. It's what economics does.

Lorraine Johnston:
Amazing. What an incredible way to end this podcast. It's been an absolute pleasure having you with us today, Sahar. The insights have been incredible. Thank you so much for taking the time.

Sahar Shamsi:
It's my pleasure. Thank you for having me.

Lorraine Johnston:
Thank you for listening to this episode of ESG Matters at Ashurst Perkins Coie. I hope you found this episode insightful. To subscribe to future episodes of Game Changers and to hear previous episodes, click on the link in the show notes or search ESG Matters on Apple Podcasts, Spotify, or wherever you get your podcasts. And while you're there, please feel free to leave a rating or a review. But in the meantime, thanks again for listening and goodbye for now.