Beyond Peak Credit A New Approach to Energy Investment Chris Cook Claverton 25/26 October 2008

We live in Interesting Times…..

… .some say, “the end of the financial system as we know it”

Most people have now heard of Peak Oil....

… .but last year we reached the point of Peak Credit....

A Green New Deal has been proposed...

.....to achieve the massive investment in energy infrastructure we need....

...but this proposal is still based upon an unsustainable financial system….

… where Money is Debt....

Where did it all go wrong?

A Bank is a Credit Intermediary – or “Middleman” £ £ Bank Borrower Depositor

But it does not lend pre-existing money….

… .it creates new money as interest–bearing credit….

… .which is then deposited back into the system

Now, if you think about it, a bank’s true economic function….

… is to guarantee that the borrowers’ credit is good…

Interest is charged for the use of the guarantee Interest Bank Borrowers

..from which Interest is paid to Depositors.. Interest Interest Bank Borrowers Depositors

..Default and Operating costs deducted... Interest Interest Costs Bank Borrowers Depositors

..and a profit to Investors normally results Interest Interest Costs Investors Bank Borrowers Depositors

So Banks create a Pyramid of Credit, on a base of Equity Bank Credit Bank Equity

Demand for Credit has been so high…

… .that Banks began to “outsource” their guarantee to rid themselves of risk.

… and thus allow Equity to support more credit creation

Banks outsourced risk totally – through “securitising” debt and sale to investors….

… temporarily – with “Credit Derivatives” (a time-limited guarantee)….

… and partially – using credit insurance from insurers such as AIG

The Result is a bigger Credit Pyramid than Banks alone could sustain… Investor Equity Credit Bank Equity

… and an opaque “shadow banking system” of Investors holding “sliced and diced” risk… Investor Equity Credit Bank Equity

This extended Pyramid of Credit funded the “Mother of all Bubbles” in US property prices….

… and servicing this credit finally exceeded the financial capacity of the US population.

… the point of Peak Credit ....

In August 2007, the Bubble started to deflate and attention turned at last to defaults …

..but by now no-one knew where the Risk lay… Investor Equity Credit Bank Equity

Banks started to think, “if this is what our balance sheet looks like…..”

“… what does everyone else’s look like…..?”

...and Banks stopped lending to each other ...

The problem is not shortage of money - liquidity – Central Banks can handle that….

… ..it is shortage of Equity - a Solvency problem – which Central Banks cannot handle…..

Bank Equity is being eaten away by defaults….

… and Investors will not recapitalise the shadow banking system...

The Result? Equity Credit

So, Credit is becoming both scarce and expensive….

… Central Banks are irrelevant….

… and further defaults will destroy yet more Bank Equity…..

… .and drain money out of the system in a “deflationary spiral”....

… .leading inevitably to a Depression....

So much for the Credit Crunch problem

Clearly the solution cannot lie in creating more credit

So we will take a new approach to “Equity” investment instead.

Conventional Equity consists of shares in a Limited Company or “Corporation”….

Ownership by a Corporation is what makes the “Private Sector” Private

While the Corporation may be conventional, it is not the only enterprise model there is

While all eyes have been on Credit innovation…

…” Asset-based” finance has been developing “under the radar”….

Canadian “Income Trusts” use a Trust law framework to “unitise” gross Corporate revenues….

Income Trust Income Trust Corporation Gross Revenues Unit Investors % % Units Costs Dividends?

Units are sold to risk averse investors such as pension funds…

… who consider investment less risky if they access corporate revenues…

… . before the management does….

We are also seeing new asset classes such as Exchange Traded Funds (“ETF’s”)….

… Real Estate Investment Trusts (“REIT’s”)…

… Hedge Funds constituted as Limited Partnerships…

… and of course….”Sukuks”

In 2001 the UK introduced the Limited Liability Partnership (“LLP”) – not in fact, a “Partnership”

… but simply an infinitely flexible corporate form – an “Open” Corporate ......

… enabling a Capital Partnership....

Productive assets are held by a “Custodian”.... Assets Custodian Ownership

… Investors put in Financial Capital in money, or “money’s worth”… Assets Investors Ownership Financial Capital Custodian

… Managers put in Human Capital of time, expertise and experience.... Assets Investors Managers Ownership Human Capital Financial Capital Custodian

… and Users pay for the use of this Capital… Assets Investors Users Payment Managers % % Use Custodian

… the result is a “Capital Partnership” Assets Investors Users Managers Custodian

A “Capital Partnership” enables new forms of Equity…

(a) Equity Share Units - proportional (%age) ”n’ths” such as billionths.....

… ..which may be bought and sold, but never redeemed, because there must always be 100%

(b) Redeemable Units – eg Kilo Watt Hours; rights to occupy 1 hectare of land for a year….

Such Units have a value in exchange, but carry no rights to production or income over time…

They hold their value because they are asset-based on value provided by the issuer …

… .rather than being deficit-based upon a claim over value issued by a Bank

Let’s have a look at how an Energy Partnership might work.....

Imagine that a community wishes to build a wind turbine...

Energy Pool Custodian Energy Energy Energy Turbine Investors Community Managers

Managers are entitled to a %age of production

Investors provide development Capital by purchasing redeemable Units

Contractors may invest equipment & materials but must invest their agreed profit margin

Contractors’ costs are covered by selling Units from the “Production Pool” to investors...

If electricity price rises, Investors gain and community foregoes part of the profit…

..if prices fall, community has locked in the price and Investors lose....

Imagine that a community wishes to retrofit combined heat and power....

Heat Pool Custodian Units Units £ £ £ CHP Investors Community Managers

A Pool or Fund is created and invested in CHP and a heat network....

....properties are subject to a “Hot Water Rate” which is paid into the Heat Pool....

....at a suitable market price...

Finance is raised by Unitising future energy production or heat savings…

… replacing conventional secured debt with a new form of redeemable Equity...

… and the Pyramid of Risk is very different…. Management Equity Investor Units Community Equity

A Carbon Pool…. Carbon Pool Energy Users Managers Custodian Units % of Units Units £ Levy £ Investors

… .is created by a carbon levy and the fund is unitised at an initial market price....

… .interest free investment is then made in Energy Pools (renewable Mega Watts)...

… .and in Heat Pools (NegaWatts – the cheapest energy of all) - eg retrofitting CHP...

… .where interest-free investment is repaid by purchasing Units from the Pool...

… .funded by energy savings made....

Units in the Carbon Pool are distributed fairly to energy consumers generally...

… .who may redeem them against energy used...

… .or to repay investment (interest-free energy loans...) in energy efficiency...

… .or simply sell them at the market price...

The outcome is that those with above average carbon use ...

… .make a net transfer to those with below average carbon use ...

A Carbon Pool enables a Carbon currency based upon the intrinsic value of energy…

..rather than a market in value-less Units of CO2 emissions, imposed by governments …

… .and designed by the same people who brought us the Credit Crunch….

A trader’s metaphor illustrates the fundamental uselessness of a deficit-based carbon currency…

“ If you want to keep a cow healthy, you don’t regulate what comes out of it……

“…… you regulate what goes in….”

Thank You,