A modest proposal on climate change

The follow up to the extremely popular “Freakonomics” — titled, like a movie sequal, “SuperFreakonomics” — has caused something of a storm over the authors’ modest proposal on climate change.

Steven Levitt and Stephen Dubners’ claim that there is a “fiendishly simple and startlingly cheap” solution to climate change has caused repercussions that have spread through and beyond the blogosphere.Freakonomics

In the current climate, turning your attention to earth’s atmosphere is likely to lead only to controversy, as Mr Levitt and Mr Dubner have found: it has already prompted a flood of entries on the SuperFreakonomics blog, as well as spirited responses from the authors themselves. Mr Dubner’s recent post has garnered over 200 comments, an equal mixture of praise and criticism.

The outline of their argument is that the climate can be artificially regulated by geo-engineering, a simple (and not original) concept, whereby a ‘hose in the sky’ would pump sulphur dioxide into the atmosphere to create a sort of force field, off of which the suns’ rays bounce. Less sun reaches the earth, its temperature cools. Simple.

The idea was first proposed by a Russian scientist Mikhail Budyko in the 1970s, and is now being investigated by Intellectual Ventures, a company owned by one of Microsoft’s leading tech alumni Nathan Myhrvold.

There is, as The Economist’s Green.view blog points out (see ‘Freaking out’), something deeply uncomfortable in Mr Levitt and Mr Dubner’s efforts to give readers a “distorted lens through which to view climate change and its solution”.

The book has its fans, like Gregory Hess, though his review skips over the chapter entirely. Many, however, are less charitable, like climate change researcher Brad Johnson’s review for The Guardian, ‘Super freaking wrong’ (the clue is in the title).

Mr Levitt and Mr Dubner’s response that they are trying to start a conversation, not have the last word. In that context, they can be proud both of the vehement opposition and the sometimes lavish praise for their argument, for example from an asset manger pal of Levitt’s.

They may or may not have anticipated — perhaps welcomed — the  heat they’ve generated (see SuperFreakonomics Authors Take Heat on Global Warming). Having posited in their first book the idea that freely available abortion helped reduce the crime rate, it is not hard to imagine that they were, at least to some extent, evoking the spirit of Jonathan Swift with their climate idea, though perhaps lacking the satirical bite of his 18th century proposal.

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Giving peace a chance

President Umaru Yar’Adua’s attempts to quell violence in the Niger Delta, Nigeria’s main oil producing region, (see Peace dividend) have received a further boost as the region’s largest militant umbrella group reinstated the ceasefire it declared prior to the government’s amnesty offer.

The Niger Delta’s main rebel group, the Movement for the Emancipation of the Niger Delta (MEND), announced a new, indefinite ceasefire on October 25th, saying that it had been encouraged by the government’s “readiness to engage” in serious negotiations.

MEND said on October 21st that it was mulling reinstating a three-month ceasefire in the heartland of Africa’s oil and gas industry, which expired last week, if the government were willing to begin “serious and sincere” peace talks.

Seeking gainful employment (for now)

Seeking gainful employment (for now)

In its latest statement MEND said it had softened its stance following last week’s meeting between Mr Yar’Adua and former rebel leader Henry Okah. MEND said that to “encourage the process of dialogue … an indefinite ceasefire has been ordered”. 

The change in tone is notable. Earlier this month MEND had pledge to fight on.

MEND’s hand may have been forced. It appears to have been weakened by Abuja’s amnesty offer in the Delta region, which has seen thousands—more than 6,000 militants according to the Amnesty Implementation Committee—of militants emerge from the delta’s Mangroves. Pipelines have been repaired and output is picking up: this has only been made possible by an improvement in the region’s security (see Delta dawn). Royal Dutch Shell, for example, resumed operations at its Soku gas plant last week, nearly a year after it was forced to close because of attacks on its pipelines.

Mr Yar’Adua this month offered to allocate 10% of Nigeria’s oil joint ventures to Niger Delta residents, potentially providing them with hundreds of millions of dollars each year in cash benefits. Details of the initiative still need to be worked out in parliament, where political support for the bill is unclear.

It is unlikely that the rapidly reformed ex-militants have surrendered all their weapons, and some intransigent rebel factions have not accepted the amnesty offer. Nevertheless, the large quantities of weapons and fighters taken out of the rebel camps through the amnesty have led many previously sceptical observers to be cautiously optimistic that the government’s efforts may bring a significant reduction in the unrest in the Delta, which has cost the country billions of dollars of lost earnings and threatened its stability.

This isn’t to say that problems in the Delta have been solved: transforming this short-term advance into the conditions for long-term peace in the region will involve a number of challenges. For example, the government must deliver on its pledge to retrain and rehabilitate militants who have joined the amnesty scheme.

Certainly the former militants could easily return to the creeks and resume attacks if the government fails to quickly find them work and a new way of life. Worryingly, some have already indicated in the media that if the government fails to fulfil its promise to give them jobs to enable them to maintain a legitimate living, they will return to the bush and resume attacking oil pipelines.

Only time (something Abuja has precious little of) will tell if the government can convince remaining militants to lay down their arms and resolve the major outstanding issues, notably over how to distribute oil revenue. This will not be easy. However, it appears that with many of its top commanders “retired” both MEND’s capacity and desire to strike have been impaired (if only briefly). MEND has used other ceasefires simply to regroup—the hope is this one will be different.

The end of cheap oil

An ominous theme emerges at a key industry event in London.

At the annual Oil & Money conference in London, there was much talk about the end of cheap oil. A boon for the industry? Not exactly. The executives that took the podium, including the heads of BP, ConocoPhillips, Eni and Hess, were cautious. They were at pains to point out, even as prices briefly topped US$80 per barrel, that these were not times of feast but famine.

After all, the new reality is that a price of between US$65-70/barrel is necessary simply to sustain investment. Both Nobuo Tanaka, head of the International Energy Agency—the energy watchdog for the world’s largest oil consuming nations—and OPEC secretary-general Abdulla El-Badri stressed that US$70/barrel is the minimum required to entice new investments.

Tony Hayward, the CEO of BP

Tony Hayward, the CEO of BP

During a panel session, Mr El-Bardi said OPEC was “ready to invest” in developing its oil reserves. He also didn’t miss the opportunity to take a swipe at biofuels—”(you) can’t have food as an energy source”; nuclear power—”(just) wait for one catastrophe”; and speculators —”There is no shortage of oil supply…we have floating storage of 125m barrels”.     

Oil and gas: here to stay  

In his keynote address, Tony Hayward, the CEO of BP, said that fossil fuels will satisfy around 80% of the world’s energy needs in 2030, even as demand increases by 45% over the next 20 years. This was heartening for his fellow oil executives, until Mr Hayward added that BP forecasts it will require annual investment of US$1 trillion a year to meet demand growth.

The BP boss also warned that “the transition to a lower-carbon economy won’t happen overnight” and urged stakeholders to be “realistic” when setting alternative-energy policy goals.

Picking up on another of Mr Hayward’s themes—that western firm’s restricted access to OPEC reserves is mostly about politics instead of geology—John Hess, head of US independent Hess, warned that a “devastating oil crisis” loomed if global action is not taken. Mr Hess’s address was a rollicking tour of the challenges facing the world.

He did not mince words “The approaches of both consumers and producers are based on hope, but what we need is a sober reality,” he said. “The reality is that an oil crisis is coming that could prove devastating to future economic growth.”

Prices up, profits down

Jim Mulva, head of ConocoPhillips (which recently lowered its 2010 capital expenditure plans) said that he expected existing spare capacity, estimated at between 4-8m b/d, to erode. Mr Mulva warned that the world is “unlikely to have long production surpluses and weak oil prices” for long. He also made the case for greater access to off-limits areas, arguing that the world needed to let international oil companies “do what they do best”.

The Economist Intelligence Unit forecasts that energy demand will fall by 2.17m barrels per day in 2009, creating excess inventories and putting downward pressure on prices. This, however, is only temporary. Long-term, the time of cheap oil is over. But for oil companies this does not mean huge earnings. Instead, they will fight over an increasingly small pool of reserves that becomes ever more costly to develop. This could make for some less collegiate exchanges at future industry gatherings.

Game theory of climate change

Bruce Bueno de Mesquita, professor of politics, New York University

In the US, it has become clear throughout the debate in both the House of Representatives and in the Senate, the divisions over energy and climate policy are not primarily along traditional party lines, as interests take many colours on both sides of argument: Democratic coal-producing districts; Republican states benefiting from federal carbon-reducing largesse; oil- and wind-heavy states that are winners and losers at the same time, etc.

The Economist Intelligence Unit’s sister publication, Roll Call, has put together an energy policy briefing (subscription required), comprised of articles and statements from a diverse array of members of Congress.

In its lead article, Roll Call concludes: “Regardless of their party and political orientation, Members seem to agree conceptually on what’s needed: Less pollution, greener energy and better economic opportunities for all those industries associated with cleaning up the planet. But they differ on how to achieve these goals, and that’s where the debate — and the fun — begins.”

The same is true of business at large, as the New York Times highlights in a story about divisions among energy companies over the bill. As the story reminds us, the divisions are mirrored in the wider business community, as the fractures at the Chamber of Commerce in recent months has underlined. With its hard-line stance on climate change policy, the national Chamber of Commerce has lost not only members it might have expected to play the “green” card – Apple, Nike, Microsoft, etc. – but a host of energy companies, including Duke, Exelon and PG&E (of Erin Brokovitch fame, no less), which have hard-nosed business interests in seeing the subsidy-laden energy bill pass into law.

With this kind of fractiousness among interested parties within the US, one can only imagine the unbridgeable fissures between parties haggling over a deal (any deal) for the Copenhagen Climate Change summit in December, a mere 50 days away. What chance of a meaningful outcome there?

Bruce Bueno de Mesquita, a New York University professor who is best known for using game theory and related techniques as a predictor of international political developments, is pretty clear. In an essay in the latest issue of Foreign Policy, he puts his view unequivocally: “Despite the hoopla, the U.N. climate change conference in Copenhagen is destined to fail.”

The first two pages of the article online – Recipe for Failure – are largely taken up with the professor defending past results of his theories, even in the face of his own – and certainly others’ – scepticism. But he goes on to explain in detail how he arrives at the conclusion that it will be impossible to get all the parties – not only the developed world and the key developing countries, but also non-governmental organisations and multinational companies – to agree to a climate deal that will have real teeth through 2050, the crucial period.

“To get people to sign a universal agreement and not cheat, the deal must not ask them to change their behavior much from whatever they are already doing. It is a race to the bottom, to the lowest common denominator. More demanding agreements weed out prospective members or encourage lies,” he writes, later pointing out, “The rich have an incentive to encourage the fast-growing poor to be greener, but the fast-growing poor have little incentive to listen as long as they are still poor.”

Thus, the Kyoto Protocol has been only a very limited success and the deal in 2007 at Bali (a precursor to Copenhagen, when the US caved in and agreed terms the last) ultimately fell apart because US lawmakers found it unacceptable. Whatever deal is reached in Copenhagen, it will fall well short of what is targeted by those who fear a two-degree worldwide temperature rise will be disastrous.

How, in the meantime, to address the climate issue in the absence of a comprehensive international treaty? Technology, in a nutshell, the professor says.

There are many areas of technological progress, of course, but that path is no smoother than the policy one, as this story on hydrogen-power for the automobile sector attests.

As Copenhagen approaches, in order to avoid doomsday depression it may be best to remember the Y2K frenzy and the fact that disaster was ultimately averted then by a whole lot of practical, boring, backroom beavering by technicians.

News wrap – Revolution talk in Paris

Secretary of Energy, Steven Chu

Talk in Paris again turns to revolution.

Steven Chu, the Nobel-winning boffin who is US President Barack Obama’s energy secretary, delivered the keynote address on opening day of the International Energy Agency’s (IEA) ministerial meeting, telling delegates from the OECD member states (joined by ministers from India, China and Russia), that indeed a scientific revolution is needed to meet the world’s energy challenge.

Welcomed into the fold after the new administration’s about-face in climate policy, Mr Chu emphasised the US commitment to combat greenhouse gas emissions with a reference (without irony) to his country’s previous success at splitting the atom to build the first nuke bomb – i.e., the Manhattan Project.

Nonetheless, the tone was primarily one of optimism, though Mr Chu pointed to rising emissions from transport as an example of the limitations of technology. The US, in common with most other developed countries, will place particular emphasis on energy efficiency.

On domestic policy, Mr Chu said he is hopeful that the senate would pass a climate-change bill prior to the Copenhagen meeting in December, though that recently looked very unlikely. The renewed optimism is founded on recent cross-party consensus, notably between Democratic and Republican Senators Kerry and Graham, which may prove a little misplaced.

He highlighted plans under the US economic stimulus package to invest heavily in energy—with loan guarantees for the nuclear industry among the proposals outlined. At the other end of the scale, there’ll be a somewhat sinister-sounding carrot and stick approach to encourage energy efficient households, with subsidies for initial investments but also a “naming and shaming” of “bad” households, which Mr Chu hopes will lead to some neighbourhood pressure to encourage action.

Though action has been snail-paced, the nuclear renaissance, it would appear, is in full-swing, in Mr Chu’s view. Also, investment in carbon capture and storage technology (CCS) is forging ahead after stalling.

With Copenhagen on everyone’s mind, Mr Chu closed with Martin Luther King Jr. quote, reminding those gathered that “tomorrow is today” and that there is such a thing as being too late.

Carbon gamble

This past summer, a writer for Rolling Stone magazine blamed Goldman Sachs for “engineering every major market manipulation since the Great Depression.” That list didn’t include a carbon derivatives bubble, but it can only be a matter of time.

It is a theory gaining a broad following: that the next Wall Street bubble – or perhaps series of bubbles – will come in markets designed to trade carbon emissions caps and permits, in other words carbon derivatives like the European Climate Exchange’s futures contract.

In the nature of bubbles, everyone wants in on the expansion phase and, with the likelihood of new nationwide carbon market in the US, exponential expansion is definitely on the cards.

Though not a certainty to pass, the energy bill proposed by Senators Kerry and Boxer, which draws heavily on the Waxman-Markey bill passed by the House of Representatives earlier this year, includes the creation of a cap-and-trade programme. The creation of a US market will not only expand the market dramatically, but some fear that it will create a whole new set of regulatory problems.

One inevitable problem of creating such a large market so quickly (estimated by Point Carbon, an Oslo-based research firm, at US$64bn in the first six months of 2009) is price discovery. In anticipation of the US market, Point Carbon has forecast the price of carbon contracts under the proposed US ETS will average US$15 per tonne between 2012 and 2019, their point being that the price of carbon is likely to be set very low. Too cheap for most activists, including Greenpeace, which estimates that a US$10 price swing on a barrel of oil alone equates to around US$24 for a tonne of carbon. Since its inception, the European Union’s emissions trading scheme (ETS) has rarely even come close to US$24/tonne carbon prices (See graph below).

Under Point Carbon’s scenario, carbon prices remain low through 2019, with the price floor providing an incentive to hold onto carbon credits early on in preparation for rising prices in later years. The low prices stem partly from US policy-makers’ desire to avoid the EU’s mistakes, which led to extreme price volatility, with a bubble followed by collapse due to the lack of a price floor.

But it is just such policy-driven constraints that are likely to increase the volatility, which means bubbles and burst-bubbles. The Europeans have been learning as they go along – while it is still a highly volatile price it has been much less volatile in its second trading period (January 2008 through December 2012) than it was in its first period (2005-2007).

Europe’s ETS accounted for 84% of the world carbon trading market, but that is likely to fall sharply in the wake of a successor to the Kyoto Protocol at Copenhagen this December. One of the main objectives for a Copenhagen agreement will be “fungible” carbon markets, which can help to provide incentives for developing countries to curb their emissions. While desirable in theory, the problem will be in the difficulty it presents for regulation. And as the world financial regulators now know, the rapid emergence of a huge derivatives market can lead to very undesirable financial “engineering” and potentially disastrous underlying policy. That’s bad enough in the housing sector, but it could be much worse in the climate change sphere.

carbon_graph

EU ETS futures, in 2nd trading phase

News wrap – The Phibro solution

Andrew Hall, publicity shy head of Phibro

The sale of Citigroup’s relatively small commodities trading unit, Phibro (2008 revenue: US$667m), to the number-four US oil company, Occidental (Oxy), has garnered outsized interest across all media.

The reasons are well known. Firstly, it stems from the enormous and embarrassing compensation due to Phibro’s chief executive and principal trader, Andrew Hall, at a time when such pay levels are deeply unfashionable. Having been bailed out by US taxpayers amid a climate of disgust at Wall Street greed, Citigroup CEO Vikram Pandit was put in an extremely uncomfortable position of having to honour a contract to pay Mr Hall some US$100m (about 40% of Phibro’s net assets, which was the “net investment” by Oxy to acquire the commodities trading outfit). Though not pressured directly by the “pay czar”, Mr Pandit took the cleanest way out and sold Phibro for what was widely described as a “bargain basement” price.

Oxy’s CFO, Steve Chazen, in a Wall Street Journal article (subscription required) was attributed the following somewhat unseemly gloat: “If you’ve got to sell, why should I pay a premium? What leverage does the seller have? They would never sell this if it wasn’t for the pressure of the government, in my opinion.”

The second reason for the sale can be seen in the contrasting fortunes of Citigroup’s and Oxy’s balance sheets. Since the financial crisis, Citigroup has lost about 90% of its market value, its shares having plummeted from around US$50 a share to below US$5 by the end of last week. Meantime, Oxy’s shares have nearly tripled in the last five years and, even after sinking last year with the oil price, recovered this year to stand at around US$80 on Monday. Also, Oxy’s CEO, Ray Irani, will not blush at Mr Hall’s pay: he received compensation in 2006 of US$450m and is regularly one of the highest paid company heads around.

The longer term question for Oxy is what exactly has it acquired in Phibro and will the trading unit change its character, especially in terms of risk, even though it is apparently tiny in relation to Oxy’s US$64bn balance sheet? “This is a company that has never gambled before, now they own a casino,” Fadel Gheit, an oil sector analyst at Oppenheimer & Co, was quoted in a Bloomberg story.

Interestingly, Citibank analyst Faisel Khan downgraded Oxy shares on Monday, to “hold” from “buy”. He wrote that company’s shares had already “priced in” the value of its production based on Citi’s medium-term outlook for oil prices – Oxy’s shares have risen by one-third this year alone.

But in a no-doubt carefully modulated assessment of its purchase of Phibro, Kr Khan wrote: “OXY has historically limited trading activities around its physical assets, and has not materially participated in anything that could be classified as speculative…Companies have begun to bring a measured amount of trading competence in-house, or have chosen to make off-balance sheet investments in proprietary trading operations. These investments have helped to bolster profitability in a volatile price environment, and have helped energy companies to better understand the market influences on their base businesses in an evolving global commodity market.”

He could have added that this has worked out very well for some companies, while others have seen spectacular losses, depending on their internal controls on risk.

As JP Morgan pointed out in a research note, Phibro’s annual pre-tax earnings averaged about US$200m from 1997 through the second quarter of this year, adding (for those unfamiliar with the volatility involved in such “proprietary trading” operations) that some years would have been many multiples above that number and vice versa. The note also pointed out that Citigroup, which did not stipulate how much capital it had to allocate to Phibro, will still conduct commodity risk management business for clients.

So, Oxy was delighted to get Phibro on the cheap; Citigroup was relieved to find a buyer. They both got what they wanted and maybe neither will end up with regrets.