Childhood dreams, the Kardashev Scale and sustainable finance

By Fred Seifert, partner, finance sector HLAC lead at ERM

Ever since I was a kid, I have wanted to become an ESG analyst. I recall spending my afternoons reviewing sustainability reports, sending angry letters to the Brazilian business journals for failing to incorporate ESG-related issues into their assessments and... That's not true – I actually aspired to be something cooler back then: an astronaut. However, I can see now that my astronomy readings to fulfill my childhood dream provided me with interesting material for my current role, such as the Kardashev Scale, which can be adapted to the world of sustainable finance.

The Kardashev Scale is a method created by astronomer Nikolai Kardashev to measure how advanced a civilization is, considering the amount of energy it can generate, control, and use. The original theory, refined over the years by scientists such as Carl Sagan, considers three types of civilization: Type I, which can harness and utilize all the energy available on its planet; Type II, which can capture all the energy directly from its star(s); and Type III, which can control and use all the energy available in its galaxy.   

While this may sound like something you would read on a Star Trek or Isaac Asimov internet fan forum, there are two powerful messages we can derive from it. First, our society's energy efficiency and effectiveness are far from being considered “advanced.” We are still struggling with controlling, optimizing, and managing the impacts of the energy resources we consume. In terms of the Kardashev Scale, we have not yet achieved a complete Type I civilization.

Unsurprisingly, we are not nearly using the best clean power with virtually endless potential – the sun. The challenges are not only technological. In addition to geopolitical issues surrounding the transition away from oil and other non-renewable energy sources, we encounter various constraints related to financial resources and incentives that support the shift towards a more sustainable (Type II?) civilization.

We need a roadmap to transition from our current “Type 0” civilization. To meet the requirements of Type I, the key focus must be on efficiency – to harness our planet’s energy potential fully, we should shift from non-renewable resources to renewable ones. This approach is not only logical mathematically (since non-renewables have a defined limit while renewables do not), it is also crucial for our survival: energy and heat generation are the primary sources of greenhouse gas (GHG) emissions; GHG emissions accelerate climate change; and climate change is the main threat to our existence nowadays.

That does not mean we should abandon all oil and coal sources and investments tomorrow. A gradual transition is the best approach; in fact, a just transition is essential. We must pursue a transformation centered on activities that generate positive developmental and environmental impacts – or at the very least, that do not generate significant negative impacts. Those activities with negative consequences should receive targeted support in the short to medium term to mitigate the social effects they can create when having their plug pulled too fast.

Therefore, the transition should be inclusive, ensuring decent opportunities for all, including those employed in non-sustainable energy sectors. Additionally, issues such as human rights and gender equality must be observed and promoted in the areas most affected by this transition. It is also important to recognize that we are not a homogeneous civilization; regions have varying financial and socio-economic conditions, affecting their capacities to progress toward a more sustainable economy. Thus, the duration of transition periods must differ based on the impacts and sustainability of various activities.

In short, we need to balance environmental and social impacts in the energy sector. While the environmental consequences of non-renewable resources are substantial and threaten our existence, the social costs of a transition that is too rapid are significant and cannot be overlooked. Inaction can bring severe and costly effects on society in the future. Just as it is important to consider the welfare of future generations and the conditions they will inherit, we must also address the needs of current generations and their ability to navigate significant social and economic changes, particularly for those with fewer resources.    

The critical focus shifts to efficacy to evolve into a Type II civilization. According to the Kardashev Scale – and considering the abundant and environmentally friendly qualities of solar energy, as highlighted by the scientific community – it is evident that solar power is the future, and we should invest more time and resources in making it more widespread, accessible and relevant. For this to happen, we should bear in mind that we need to overcome challenges related to technological development and establish a proper supply chain, guaranteeing not only environmental soundness but also health, safety, and respect for the human rights of all involved.

For this roadmap to succeed, changes in financial flows are necessary. Fiscal policy and sustainable financing should be considered. For instance, implementing “green” tax reforms and incorporating climate costs into budgetary decisions are essential steps, as are avoiding incentives that favor non-renewables while creating hurdles for environmentally positive initiatives.

This movement in the fiscal and budgetary realm must be complemented by mobilizing resources – including private investments – toward concrete transition actions. A significant funding gap exists: we estimate a need for about US$8 billion a year through 2050 to make the transition viable, yet we only allocate about US$1.3bn annually. The intensification of financial mechanisms such as green bonds and exploring blended finance possibilities are key here. 

Qualitative changes are also crucial, requiring the integration of environmental and social externalities in investment returns calculations and prioritizing long-term gains over short-term profits. This could lead to an increased offering of financial solutions directly to clients from different types of financial entities.

Due to the complexities of understanding the implications of reaching a Type III civilization based on our current knowledge and scientific development, I will not delve into that topic. However, it is worth noting that the advice from our relatives and friends to “reach for the stars” makes a lot of sense if you work in the energy sector. Of course, as we mature and enter the world of finance, we also realize we need “to reach for sustained alpha” in such investments to make them feasible and to advance as a civilization – particularly in light of the socioeconomic arrangements that we live in.     

To avoid making all this discussion too theoretical or even fictional, I am not even getting to the Drake Equation on the probability of finding extraterrestrial civilizations, which would allow us to learn how they use their energy sources. Instead, I prefer to focus on my current role at ERM, which, while not my childhood dream job, is nonetheless an exciting opportunity to support just transitions. 

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