Blame it on the recession or natural gas prices or politics or whatever else. But we cannot deny that we are in green financial crisis, and one that is steadily worsening.
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Sitting at the arpa-e summit at the end of last month, I heard Secretary of Energy Stephen Chu say that he didn't want to use "the t-word," referring to a tax on carbon or energy use. He presented a graphic of a gasoline pump flowing from the Middle East into the U.S. -- and piles of U.S. dollars flowing in return. It felt like Jimmy Carter might be backstage in his cardigan sweater providing late-'70s slides.

About 4/5 of global energy demand is met by combusting fossil fuels, the same as in 1990. The International Energy Agency (IEA) forecasts that stabilizing climate at 2C above pre-industrial temperatures implies, among other things: a $120/ton price on CO2 in the developed world, and $95/ton in China, Russia, Brazil, and South Africa by 2035.

Sure, IEA is not prescient, but it raises a key and unavoidable question: Can global energy systems be de-carbonized without a meaningful long-term carbon price?

I don't believe so.

In 1980, I began my career working on project finance in alternative energy. The U.S. had firmly decided to rid itself of high energy prices and foreign oil dependence. I felt enough wind in the sails to make this my life's work. By 1985, however, there was no work. Oil prices plummeted and alternative energy recorded its first boom-to-bust of the modern era.

Fast-forward to the present and cleantech stocks are starting to party like it's 1985. Take the previous darling of the U.S. cleantech industry, First Solar. After rising to a market capitalization of $25 billion in 2008, it's worth just a tenth of that today, and valued 1/3 less than the capital already invested in the business.

The S&P Global Energy Index (ticker "ICX") was started in 2001 and has returned 178 percent since inception. The S&P Global Clean Energy Index (ticker "ICLN") was started in June of 2008 and has lost 82 percent since inception. Green investing in current circumstances is a losing bet relative to fossil energy.

Blame it on the recession or natural gas prices or politics or whatever else. But we cannot deny that we are in green financial crisis, and one that is steadily worsening.

Having run a global capital markets business, I try to stay close to the intersection of capital markets and climate stability, where huge investment is required. The IEA forecasts an incremental $15 trillion of investment in low-carbon technologies and energy efficiency is required by 2035 (above and beyond what nations promised in Copenhagen) if we are to stabilize temperatures at 2C above pre-industrial levels.

That is quite a bit of capital. But the question, again, is whether capital markets will open to these projects in the time frame necessary if carbon emissions remain free. And, again, I don't believe so without full-on commitment to greenhouse gas mitigation.

The problem is one of risk.

When people ask about the seriousness of climate change I usually show them this picture comparing estimates of climate damage functions from the literature.

Temperature from 1-10C is on the x-axis, and probability from 0-70 percent on the y-axis. What appears obvious is that very bad things (large increases in temperature) are much more likely than good things (small decreases in temperature). The simple explanation is net positive feedbacks in the climate system like, say, melting permafrost releasing methane and feeding still more warming.

This is called fat tail risk, and is analogous to what we saw in the financial crisis. There, positive feedback meant that when a few big players didn't manage their risk in things like mortgage backed securities, the rest of the system was daisy-chained into crisis. Financial risks are reversible, of course -- albeit painfully. The same is not true for the climate system.

My colleagues and I wrote a paper in 2009 about using real options to evaluate climate policy under uncertainty. We found that, unlike indications from cost-benefit analysis, stabilizing at 2C is a very cheap option. Better still is the work of Martin Weitzman of Harvard, who aptly and eloquently writes of managing climate risk as tail skimming and grapples with the difficulty of bringing climate uncertainty into economic decision-making.

Tail skimming can happen if funding for greenhouse gas mitigation flows efficiently through the capital markets. But this will not happen if lighting a match to coal (or oil or natural gas) bears no carbon cost. We cannot "bet the climate" on technology winning out over the venerable fossil fuels, as many propose (see the recent Ted Nordhaus/Michael Shellenberger). Capital markets are just going to keep embedding fossil fuel infrastructure in global energy systems. And those new assets, like gas-fired generation in the U.S. or coal-fired generation in China, will be tough to scrap early when cleaner technologies finally attract capital.

John Doerr of Kleiner Perkins characterized the clear signal we need to give to capital markets in a single slide at the first arpa-e Summit two years ago: Just Price Carbon.

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