Will Markets Survive the End of Growth?


Whenever anyone questions the way things are, from the Occupy protestors through to people like me arguing that economic growth will end in tears and crisis, the response is very often, but “markets are wonderful and efficient way of organising our society”. I say what? That’s like saying to someone who says “I don’t like oranges” that “you’re wrong, you haven’t tasted this great cheese”. It’s an irrelevant and illogical response.

The term “markets” does not mean “infinite growth based capitalism that is destroying the ecosystem and preferentially serving the interests of the rich”! Markets don’t have to do that, and don’t always do that, including today. Indeed, markets as an idea have proven themselves as a resilient mechanism for many objectives. From the food markets of ancient Rome to the emerging boom in renewable energy, markets touch something very powerful in the human psyche and can deliver great good for society.

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Occupy Wall St is the Kid in the Fairy Tale – The Emperor Has No Clothes


As Tom Friedman recently wrote in the NYT, “There’s Something Happening Here”. There sure is. The market system that has delivered so much to the world over the last century – brought great technology, alleviated so much poverty, produced a better life for billions – is now destroying itself.

Some say this process is now inevitable. That like an empire in decline, the system is deluded by its grandeur and historical power and thus fails to see its weaknesses – so is unable to respond.  I disagree. The crisis is certainly inevitable, indeed that is well underway. The ecosystem is breaking down, and the economy is in hot pursuit in the collapse stakes. But the path into and through this crisis is a choice we get to make. The future doesn’t just happen, we create it.

But who gets to make these choices? Some argue it’s “the 1%” and that the victims of their decisions are “the 99%” – that the rich beneficiaries of the current system control it, and do so in their own interests. This analysis says that’s why we have low taxes, bailouts of wealthy investment banks, lack of action against those who caused the financial crisis and a failure to deal with climate change – because the rich 1% want it that way. But is that correct? And if so, are they making the right decision even for themselves?

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Like a Grenade in a Glasshouse


It’s going to hit hard and it’s going to hurt – made worse because most aren’t expecting it. They think the world is slowly returning to our modern “normal” – steadily increasing growth, with occasional annoying but manageable interruptions. After all, the global recession wasn’t so bad was it? Sure there was pain and things got shaky but Governments responded, bailed out companies, stimulated economies, got things back on track.  While it’s still a bit bumpy, Greek wobbles, US debt, extreme weather, high oil and food prices etc, it’ll work out. It always does….

If only it were so. In fact we are blindly walking towards the next in a series of inevitable system shaking and confidence sapping crises, deluded in the belief that the worst is behind us.

Each crisis will be a little worse than the last. Each one will shake our denial a little more. This is what happens when systems hit their limits. They don’t do so smoothly, but bump up against the wall, hitting hard, then bouncing off equally hard. It is the behaviour of a system trying to break through. But if the limits are solid, as is the case with our economic system hitting the limits of the planet – defined by unchangeable physical capacity and the laws of physics, chemistry and biology – then it can’t find its way through. So eventually, when the pain of hitting the wall gets too much, it stops.

Then it will hit. Like a grenade in a glasshouse, shattering denial and delusion and leaving it like a pile of broken glass on the floor of the old economic model. Then we’ll be ready for change.

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China confronts the limits to growth


Economic growth is slowly but surely coming to an end, not for a few quarters or years, but to an end. It will still take some time given the mighty momentum behind it, as well as the power of our denial, but the signs are clear that both processes have begun.

Let me be clear that I’m not talking here about the long philosophical debate on the relative merits of growth – that rich countries getting richer does not improve their quality of life. What we face now is not a political choice – it’s too late for that. We have put in place the processes that will force the end of growth and nothing can now be done to change course.

China is perhaps the best example, exaggerating all that is good and bad about the growth model. We have seen spectacular rates of growth in recent decades and with it, many hundreds of millions of people being brought out of poverty. These people are now enjoying the fruits that global growth has delivered to many of us over the last century in technology, health and easy access to food. On the other hand China has paid an enormous price for this growth, in air pollution, degraded soil quality, spoiled waterways and longer term risks to food supply. It is now even taking from the USA the ignominious title of being the world’s largest current contributor to climate change (though we mustn’t forget China’s per capita emissions are still dwarfed by the pollution rate in the OECD countries).

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The Great Disruption has arrived


Why didn’t more of us see it coming? After all, the signals have been clear enough – signals that the ecological system that supports human society is hitting its limits, groaning under the strain of an economy simply too big for the planet. But we didn’t and, as a result, the time to act preventatively has passed.

Now we must brace for impact. Now comes The Great Disruption.

It is true that the coming years won’t be pleasant, as our society and economy hits the wall and then realigns around what was always an obvious reality: You cannot have infinite growth on a finite planet. Not ‘should not’, or ‘better not’, but cannot.

We can, however, get through what’s ahead – if we prepare. I wrote my forthcoming book, The Great Disruption, to help us do that. My conclusion in writing it was this:  not only can we make it through, we can come out the other side in better shape.

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How free market advocates have delivered us big government


We all know the argument; Governments are inherently ineffective at guiding markets and will always screw it up when they try to. Markets, the argument goes, are inherently more efficient at picking technologies and responding to constraints, so should be left to do their thing.

People who want to resist change, for any number of reasons, latch on to this argument as another excuse to avoid action on climate. After all, even if climate is a problem, government will surely get it wrong if they try to fix it. It is this argument, along with climate scepticism and the over-riding priority given to economic growth, which has, in various combinations, been used against climate action since the threat became clear in the late 1980’s.

Yes, we forget how long this problem has been in the mainstream debate. It was back then that the pro-market, conservative British Prime Minister Margaret Thatcher argued: “The danger of global warming is as yet unseen but real enough for us to make changes and sacrifices, so that we do not live at the expense of future generations.”

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Coal crash coming?


The very conservative International Energy Agency has just released its closely watched annual World Energy Outlook (WEO), with forecasts for the structure of the energy market through to 2035. This year’s WEO was much anticipated, given the pace of developments in renewables and climate policy, and it didn’t disappoint. The report included the IEA’s interpretation of what major governments’ commitment to a 2°C temperature target would mean for the energy market. The contrast with what most market players assume, particularly coal companies, could hardly be more dramatic.

One global coal player, Peabody, recently told the World Coal Conference that it assumes demand for coal will increase by over 50 per cent by 2030. The IEA on the other hand tells us that if we are to have a reasonable chance of limiting warming to 2°C degrees, coal demand will have to peak by 2020, and by 2035 will have dropped to levels last seen in 2003. These are dramatically different views of the market and the implications for company valuations, and therefore for investors and corporate strategy, are considerable.

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Are the Financial Markets Turning on Climate?


The future is now closing in on us rapidly and the resulting shifts in investment markets are gathering pace. When Phil Preston and I started working on the paper we released here last week, Carbon Induced Financial Disruption, the idea we were advocating – of disruptive change in financial markets driven by market’s pricing in carbon risk – seemed like a radical one. That was just March this year, yet six months later similar ideas are taking hold across the mainstream market and in the business press.

In June this year, Deutsche Bank said they thought that, in Europe, “coal is basically out of the game as a new build choice with carbon prices above €30/tonne”. This level now seems inevitable if we’re to come anywhere close to agreed policy targets for emissions. As reported in Climate Spectator last week, analysts from Citigroup have started looking at how individual company share prices might perform if governments take strong action on carbon emissions. I think such action is inevitable if we pursue the 2 degree temperature target governments have already adopted. We are even seeing major global coal miners like BHP Billiton acknowledging the inevitability of a carbon price and encouraging it to be brought in sooner rather than later to ensure countries like Australia can maintain competitiveness in a low-carbon economy.

The mainstream business press is also starting to raise the future of climate policy as a consideration in investment decisions. In Australia, the offer documents in the planned privatisation of Queensland Rail through a public float features the coal they carry as the key selling point. They proudly point to the enormous volumes of coal that underpin the business – around 200 million tonnes in 2010. The business press meanwhile is raising the risks such a focus on coal poses to investors if strong carbon pricing is put in place, quoting analysts views on the subject. While it is true that most analysts still believe coal has a rosy future, the fact that it is being incorporated into their thinking at all is a major shift compared to just a year ago.

Of course if governments can off load carbon-exposed assets to investors that’s good news for taxpayers, but it’s bad news for investors who don’t take account of carbon risk.

Another interesting development is that some of the luminaries and elder statesmen of the investment world are stating to pay attention to these issues. In July this year legendary contrarian investor, Jeremy Grantham published his views on climate change. With his company GMO managing around US$100 billion in funds, other investors take his views very seriously. While Grantham acknowledged it was still tough to know how to make money out of climate change, he made the case that investors need to rapidly answer that question because “global warming will be the most important investment issue for the foreseeable future.”

Then, last week, Bob Litterman, the former head of Goldman Sachs’ quant group and an MIT economics professor, suggested in a speech to sovereign wealth fund managers that unpriced carbon risk could be the next financial crisis to grip global markets. The speech makes fascinating reading for those who want a financial analysis of carbon risks in the global market and why, when change happens, it is likely to be sudden and dramatic, as Phil and I argued in our paper, not slow and steady as most investors assume. If you want to see Litterman’s full analysis you can read it here.

The implications of all this however are not just the risks for fossil fuel investments but the enormous upside inherent in the transition to the new energy economy. The smart money senses the time has come and billions are now flowing into renewables, getting ready for the inevitable boom that will be driven by the transition. With over $100 billion invested per year in both 2008 and 2009, we are now talking serious money. Of perhaps even more significance was that in both years more money was invested in new renewable power capacity than in new fossil fuel capacity, indicating a tipping point has been reached.

The context here is key to understanding what’s to come. We haven’t actually decided to fix climate change yet, with much policy action stalled both globally and in key markets like the United States. This means what we are seeing now is just a small taste of what’s to come when we really get moving. As Jeremy Grantham argued, this is the most important investment issue around and as Bob Litterman points out, the process of change will not be slow and smooth but late and sudden. Given it is already “late”, it’s now time to hold on for the ride. But you might want to make sure your investment portfolio is ready.

Risky Business – Is the Carbon Shock Imminent?


The only sure thing in how climate change will unfold in politics and the economy is that it will happen in surprising and unexpected ways. This reliable fact has been on my mind as I’ve worked with investment and risk expert, Phil Preston, on a major new paper we are releasing today that looks at carbon investment risk through the lens of climate science.

We examined whether the tipping point for the now inevitable economic transformation could occur in financial markets rather than in the world of politics or public opinion. This is the opposite of what most people expect – they assume that regulation and the pricing of carbon will be the trigger for market shift. But what if markets move first by pricing in risk and what if they do so more quickly and more dramatically than anyone expects?

In considering this possibility, Phil and I focused on the most important issue facing investors with carbon risk  – the vexed issue of timing. While collapse in value is a huge issue for companies, it doesn’t really matter for an investment manager if they can pragmatically assess the risk and get out before a price collapse. Timing is really the only key unknown with climate risk because any dispassionate investor knows that carbon exposed assets, particularly coal companies, will drop in value at some point. This is inevitable because for CO2 emissions to fall at the scale science demands, it requires governments to phase out our use of coal, oil and gas well before discovered reserves are used up. But the question is when?

There are two aspects to the timing. Firstly will this value collapse occur suddenly over months or gently over 20 years and secondly, will it start soon or is still decades away?

We started by looking at what the scientists were saying, as this is the underpinning of everything else. Politics and markets work to human emotions and beliefs, which means change is influenced by negotiations, delays and preferences. Science doesn’t work like that. The rules of physics, chemistry and biology are set in stone and don’t negotiate with us. What the science says is that allowing 2 degrees of global warming above pre-industrial levels is a step too far. It takes us into territory where system wide feedbacks could spiral out of control and threaten the stability of the global economy, perhaps even civilisation. Some argue even 2 degrees is way too high, noting this would still involve catastrophic impacts such as the likely loss of all coral reefs, quite considerable sea level rise, increased extreme weather and unstable food supplies. The fact that governments consider all that to be manageable just emphasises how bad going past 2 degrees is.

So responding to the science, all the big emitters including the US, China, EU and India have agreed that 2 degrees is the line in the sand we must not cross. This is not a radical view, having been endorsed by the likes of GE, HSBC and Rio Tinto and hundreds of other corporations at the Copenhagen climate conference. So we concluded 2 degrees was the rational basis for assessing economic and financial market impacts of climate change, particularly in terms of timing.

The next question then becomes what will achieving this goal require society to do? The highly respected Potsdam Institute for Climate Research provides the most useful basis from which to answer this question. They developed a “carbon budget” – how much CO2 in total can we put in the atmosphere if we want to limit warming to 2 degrees? Their answer was framed in probabilities, recognising as a society we will ultimately have to make a decision on how much risk we want to take. This is an interesting question – if 2 degrees of warming represents an unacceptable risk of a runaway climate and global collapse, how much risk do we want to take? Phil and I thought “not very much at all” would be a good answer! Maybe 5%?

But we ended up using their analysis that accepted a 20% chance of going past 2 degrees, recognising this was probably a real world assessment of where the politics will end up. Potsdam also gave the option of 50% but this seemed highly unlikely given the consequences of exceeding 2 degrees are catastrophic and quite possibly irreversible.

So assuming a 20% chance of a manageable future, our carbon budget is 890 billion tonnes that can be emitted between 2000 and 2050. Given we’re well into this period and assuming growth as forecast, the next question becomes – when is the budget all used up? The answer was quite startling. It’s all gone by 2024, just 14 years away. The other startling conclusion was that a full 75% of proven reserves of oil, coal and gas would then be still in the ground, never to be used, meaning they are today probably worth nothing.

When we considered this as an investment question, the logic flowed clearly. First we concluded that despite the lack of action to date, we will inevitably act and act strongly. This is what history says we do, whether it’s WWII, the financial crisis or any number of smaller scale issues, we wait until the crisis is full blown then we act dramatically. With 2 degrees an immoveable limit, approaching the point of no return on our way there becomes the crisis. However we can’t stop emitting suddenly in 14 years time, that would trigger the economic collapse we’re trying to avoid, so logically we will have to take strong action before then. This is where it gets interesting for investors.

Financial markets do not act in a smooth and orderly manner. They are like waves approaching the shore, in this case more like a tsunami. While at sea, a building tsunami is hardly perceptible and if you were floating on one you wouldn’t notice it as your boat quietly rose and fell while it passed underneath you, like the tipping point in support for action on climate that we’re floating on right now. However as the tsunami approaches the shore, it builds height because the constraint of the ocean floor below leaves it no where else to go, like our fossil full budget has a precise end date – immovable by politics or markets because its defined by physics and chemistry. As such waves or investment trends hit the shore their enormous power races across the ground sweeping away all before them.

Hard to imagine? Yes it certainly is. But it’s certainly no harder to imagine than the only alternative – doing nothing as we head towards economic collapse. Remember as an investment risk question, the question is not “will this be the outcome”, but “is there a reasonable risk of this being the outcome”. Then that level of risk is priced in.

Perhaps the most interesting conclusion we came to was that such a carbon induced financial disruption was likely to approach quite suddenly and relatively soon. We believe markets won’t wait for government to act. Markets will pre-empt this by pricing in the risk that governments will take the action science demands and that they’ve already agreed is correct.

In financial markets very few like to be first out the door but absolutely no one wants to be last. So the immovable logic of the rapidly diminishing carbon budget means the rush for the exits may come tomorrow, next year or in 5 years time. With the end date of 2024 set in stone, the clock is ticking.

You can download the report here. I look forward to your reactions.

Why I don’t believe in the climate science


It’s time for a true confession. I don’t believe in climate science.

That’s because I’m a rational person. Belief is important in my life and I apply the term to things involving faith. Faith is how we believe when there is no rational basis for a decision – which doesn’t mean its irrational or wrong, just that there is no evidence to support the view taken. Faith and belief often apply to matters of the spiritual realm. But they also apply to matters of a more worldly nature, where the capacity for faith and belief has framed many positive developments in humanity over history. Despite the lack of supporting evidence, Churchill believed the allies would win WWII and Mandela believed majority rule would come, relatively peacefully, to South Africa. Faith is a powerful driver of human behaviour.

However, I don’t “believe” in climate science because it’s not a religious or a faith question. It’s just numbers and science on which to make rational judgements. The scientists tell us what they know, and what they don’t, and we decide how to respond. This is not a binary question, like the earth is flat or not, this is a system description based on best available knowledge.

Belief is actually a dangerous concept in relation to climate science and we should stop using the word in that context. Because belief is based by definition on “non-rational” thought, framing it this way leads to a tendency to resist counter arguments and associated data. It’s hard for more data to change a belief, because it wasn’t data based to begin with. As a result, interpreting science using a belief based approach leads to sloppy intellectual behaviour, where we discount data that challenges our “beliefs” and exaggerate the importance of data that supports them.

Climate science is at it essence just data. Always incomplete and open to challenge and debate but, fundamentally, just data which we then interpret and act on. We navigate this at times complicated process quite successfully in a range of other fields such as aeroplane and bridge design, food safety and medicine.

Where this process occurs in the absence of strong cultural or economic self-interest, there is little controversy, such as bridge design. As we move into economic self-interest, things get a little complicated, such as the reappraisal of safety levels for volcanic dust during the recent Icelandic volcano, when airlines pushed for a review, based on economic losses, from the application of what they saw as too strict an interpretation of the data. Again it worked out fine.

When we move into areas of strong cultural influence and beliefs, such as medicine and health, things get more complicated. So, for example, whereas many traditional medical scientists would argue the evidence for some alternative therapies is weak, people act on their “beliefs”, spending over many billions on them each year, including some where the science is definitely not proven and sometimes quite disproven.

In all these areas though, from bridges to medicine, as a society overall we accept the dominant scientific conventions. When a body of qualified scientists reviews the evidence and issues their judgements we generally act accordingly and the broad societal level. We make decisions on flight safety, on bridge design and on public health – not without controversy, but in the end we make decisions and we base them on rational thought.

Sometimes, though, it gets really messy, and such is the case with climate change. Here we see a great clash of cultural and political beliefs, mixed up with enormous economic self-interest. The result is quite irrational, belief-based debate and decision making or, in this case, the lack of decision making.

It’s important to recognise what’s going on in this process and to respond appropriately. So, for example, we should by now know that arguing science with a climate denier (as opposed to a genuine sceptical scientist) is as pointless as arguing the benefits of market economics and liberal democracy with an al Qaeda leader. No amount of rational data will help because they don’t want to believe, so they will deny any evidence that confronts their own beliefs.

The right approach with climate deniers is to ignore them. Fortunately their influence is on the wane and their cause now quite terminal because, in the end, we are a rational society and the evidence is clear. As US Senator Daniel Patrick Moynihan said: “Everyone is entitled to his own opinion, but not to his own facts.”

For genuine sceptics, and indeed for all of us, it is very important we maintain an open mind and keep the debate alive and vibrant. We must act urgently to reduce the risk of climate change by eliminating the net CO2 emissions of the economy as a fast as possible. But we must also keep researching, challenging and exploring the details as we do so, not least of all to identify the most effective actions we can take. Not all greenhouse gases are the same and, given what the science tells us about the urgency, it is going to take all of our ingenuity to pull us back from the cliff we seem to be racing towards.

So when someone asks if you’re a climate believer, tell them no, your far too rational for that.