The climate and the fat tail risk

Last month at the gathering of the great but not good, the rich and infamous, at the World Economic Forum in Davos, US Treasury secretary, Steven Mnuchin, formerly a hedge fund manager, was asked whether he agreed that calls by teenage climate activist Greta Thunberg for public and private-sector divestment from fossil fuel companies would threaten US growth.  He said it would and Mnuchin jibed: “Is she the chief economist? Who is she, I’m confused… After she goes and studies economics in college she can come back and explain that to us.”  Thunberg retorted: “My gap year ends in August, but it doesn’t take a college degree in economics to realise that our remaining 1,5° carbon budget and ongoing fossil fuel subsidies and investments don’t add up.”

Thunberg may not be an economist (which may be to her advantage), but the economics of global warming and climate change is concentrating the minds of many economists, if not Mnuchin.  JP Morgan economists recently considered the issue of the “financial stability and economic risks from fossil fuel stranded assets: oil, coal and gas reserves that cannot be exploited due to the transition to a low-carbon economy.”  They reckon that up to US$20tn could be wiped from stock market values if it is realised by investors that reducing fossil fuel use would mean a sizeable portion of proved reserves held by energy companies may never be used. These ‘transition risks’ to the profits of the energy companies would be equivalent to 17% of the US$119tn global fixed income and equity markets.

So JP Morgan economists tried to work out what could be the minimum reduction in fossil fuel use to avoid losses for the energy companies and financial markets. The lower the target limit on greenhouse gas emissions, the greater the risk of ‘stranded assets’ (unused) on the books of the companies.  The size of stranded assets would depend of the temperature target, which in turn would depend on government policy decisions and on technology innovations to reduce energy use and carbon emissions over the next generation.

The International Energy Agency (IEA) has a ‘Sustainable Development Scenario’ which it claims to limit the global warming increase to 1.8⁰C relative to pre-industrial times, with a 66% likelihood.  In this scenario, energy-related CO2 emissions are assumed to peak immediately (yes, right now!) and then fall to reach zero in 2070.  If that actually happened, then, according to JPM, 87% of the current proved coal reserves, 42% of current proved oil reserves and 26% of current proved natural gas reserves would need to be left in the ground if the temperature gain were to be limited to 1.8⁰C.

The IEA also has a ‘Stated Policies Scenario’, which is intended to reflect the effects of policies that governments have already implemented with an assessment of the likely consequences of policies that governments have announced but not yet implemented. Finally, there is the ‘Current Policies Scenario’ which is where governments ignore or do not implement all stated current climate policies. What the IEA finds is that the Stated Policies Scenario shows some relative improvement in reducing carbon emissions compared to the Current Policies Scenario, but it is a long way short of the Paris 2⁰C objective.  Indeed, the Stated Policies Scenario would be consistent with an increase in the global temperature of around 3⁰C!  That would have devastating effects on the climate.

The difference between the temperature increases in the Sustainable Development Scenario (around 1.8⁰C), the Stated Policies Scenario (around 3⁰C) and the Current Policies Scenario (around 3.5⁰C) may not seem very large.  But they are for the world economy, human society and ecosystems.  Climate change is about much more than an increase in the temperature. It is also about the frequency and intensity of extreme weather events (such as heatwaves, droughts, flooding, storms, and tropical cyclones), shifts in atmospheric and oceanic circulations, declines in ice cover and sea level increases.

But here is the crunch for the energy companies and financial markets.  Even in the IEA Stated Policies Scenario, the stranded assets for coal are still large, at 67% of the proved reserves. But there are no stranded assets for either oil or natural gas. Indeed, the cumulative extraction of oil from 2019 to 2070 exceeds the level of proved reserves in 2018 by 215.7 billion barrels (12%of proved reserves in 2018), while the cumulative extraction of natural gas from 2019 to 2070 exceeds the level of proved reserves in 2018 by 68,525 billions of cubic meters (35%of proved reserves in 2018). JPM comments: “These calculations help to explain why companies are still exploring for new oil and gas deposits, despite some dire warnings about stranded assets.”  In other words, existing government agreements to reduce fossil fuel use and carbon emissions will not damage the profits of the oil and gas multinationals at all, but also will fail to stop the inexorable rise in global warming to increasingly destructive levels.

JPM economists pin their hopes on squaring the circle through the development of carbon capture and storage (CCS) technology, which aims either to prevent CO2 emissions from energy production and industrial processes that use fossil fuels from entering the atmosphere or to remove CO2 from the atmosphere completely (see graph above). The CO2 captured would then need to be stored underground. The more effective the CCS technology, the less pressure on stranded assets; and the less the loss of profits for energy companies.

At the moment, there are three technologies in theory that could do this. First, carbon capture and storage (CCS), where the emissions from power plants and industrial processes are captured before they enter the atmosphere. Second, biomass energy carbon capture and storage (BECCS) where energy is produced by plant material (which has absorbed CO2 while growing) and the emissions are captured before they enter the atmosphere. This generates negative emissions. And third, direct air capture and carbon storage (DACCS) where CO2 is extracted from the atmosphere directly. This also creates negative emissions.

In reality, these technologies are not going to do the job.  Currently, there are 19 operational CCS facilities, with 32 under construction or development. These facilities have the capacity to capture around 40Mt of CO2 per year. This is just 0.1% of the current energy-related CO2 emissions of around 33Gtper year.

Then there is the Nightmare Scenario.  Some recent scientific projections suggest that a ‘business-as-usual climate policy scenario’, as promoted by the likes of Mnuchin, is expected to deliver a temperature increase of around 3.5⁰C; dangerous enough.  But the impact of climate change is likely to come just as much from an increase in the variance as from an increase in the mean.  Up to now scientists concur that the Earth could warm 3°C if CO2 doubles. But the latest models suggest even faster warming — recent model projections on global warming from various sources are suggesting a rise in global temperature in excess of 5°C.

Indeed, a Pareto probability distribution function of the current projections have ‘fat tails’ that suggest there is a 1% likelihood of a 12⁰C increase in temperature.  Weitzman:“the most striking feature of the economics of climate change is that its extreme downside is non-negligible. Deep structural uncertainty about the unknown unknowns of what might go very wrong is coupled with essentially unlimited downside liability on possible planetary damages.”   

With that kind of temperature increase, human life would probably not survive. But even worse, says JPM economists, “in such a catastrophic outcome, all financial and real assets would likely be worthless.”!

And yet governments continue to allow energy companies to search for and develop more fossil fuel resources.  And this is not just in so-called emerging economies which need growth.  Canada’s Liberal government claims to be a leader in fighting global warming.  But the government has still agreed to allow the development of the biggest tar sands mine yet: 113 square miles of petroleum mining. A federal panel approved the mine despite conceding that it would likely be harmful to the environment and to the land culture of indigenous people.

These giant tar sands mines (easily visible on Google Earth) are already among the biggest scars humans have ever carved on the planet’s surface. But Canadian authorities ruled that the mine was nonetheless in the “public interest”.  Justin Trudeau, recently re-elected as Canada’s prime minister, put it in a speech to cheering Texas oilmen a couple of years ago: “No country would find 173 billion barrels of oil in the ground and leave them there.” So Canada, which is 0.5% of the planet’s population, plans to use up nearly a third of the planet’s remaining carbon budget.  There’s oil in the ground and it must come out.

It’s the future of the planet and its species versus the profits of the multinationals.

36 thoughts on “The climate and the fat tail risk

    1. ”But, but, but, there is no CO2 problem at all, at all.” I shall certainly sleep the sounder in bed tonight from learning of it. I have so many other things to worry about. The American scientist G R McPherson has listed them in today’s Counterpunch online magazine:

      insect apocalypse

      meltdown of the world’s nuclear power facilities

      air travel causing global warming by destroying cirrus clouds

      accelerating melting of ice in Artic/Antartica

      diminishing aerosol masking effect

      ocean acidification and demise of plankton

      threat of abrupt release of methane from melting terrestrial permafrost.

      So it’s goodnight to you and goodnight to the rest of Humanity.

      PS On being challenged by his daughters about what an aristocratic old gentleman like he would do when the revolution came, Dr Marx answered something to the effect, ”I am only happy, my dears, that I shall not be around to see it.”

      I can only affirm that I shall be only too happy to be around long enough to say, ”Told you so!”

      1. ”An iceberg about twice the size of the District of Columbia broke off Pine Island Glacier in West Antarctica sometime between Saturday and Sunday, satellite data shows, confirming yet another in a series of increasingly frequent calving events in this rapidly warming region.

        The Pine Island Glacier is one of the fastest-retreating glaciers in Antarctica, and along with the Thwaites Glacier nearby, it’s a subject of close scientific monitoring to determine whether these glaciers are in a phase of runaway melting, potentially freeing up vast inland areas of ice to flow to the sea and raising sea levels.” The Washington Post yesterday!

        Meanwhile the Fukushima owners intend to dump the radioactive water from their cooling tanks, being full, into the Pacific.

        Please tell me they pay you to write this stuff?

      2. ”The Antarctic has registered a temperature of more than 20C (68F) for the first time on record, prompting fears of climate instability in the world’s greatest repository of ice.

        The 20.75C logged by Brazilian scientists at Seymour Island on 9 February was almost a full degree higher than the previous record of 19.8C, taken on Signy Island in January 1982.” Today’s ‘Guardian’

      3. So you believe guardian and WP. Interesting! Tony Heller is much more serious and much more funny.

      4. ”So, you believe the WP and not a serious scientist like me. Interesting!”

        ”it’s a subject of close scientific monitoring” and

        ”The 20.75C logged by Brazilian scientists at Seymour Island on 9 February ”

        Sorry, serious scientist, but have you been to the Antarctic to conduct on the spot research? Seriously, maybe you should go!

      5. ”Joke of the month” I take it that means you won’t be going, but if do you change your mind, don’t forget to pack your shorts!

      6. ‘The Triumph of Doubt: Dark Money and the Science of Deception'(OUP David Michaels 2020) traces the ascendance of science-for-hire in American life and government, from its origins in the tobacco industry in the 1950s to its current manifestations across government, public policy, and even professional sports. Well-heeled American corporations have long had a financial stake in undermining scientific consensus and manufacturing uncertainty; in The Triumph of Doubt, former Obama and Clinton official David Michaels details how bad science becomes public policy ― and where it’s happening today.

        Amid fraught conversations of “alternative facts” and “truth decay,” The Triumph of Doubt wields its unprecedented access to shine a light on the machinations and scope of manipulated science in American society. It is an urgent, revelatory work, one that promises to reorient conversations around science and the public good for the foreseeable future.

        Did somebody say funny money, B.B.?

      7. Tony Heller
        ”On Valentine’s Day 1962, it was 78 degrees at Mt. Vernon, Indiana.” BB’s scientific adviser!

      8. I was in Science for 45 years of which 30 yrs at the top. Over those yrs I have seen the increase of corruption in Science to a level that a large part of Science has become ridiculous. This is also the case in Europe where I live. Those 30 yrs I spent in the space business where corruption is low, otherwise those systems in space would never work.

      9. Dr. Elliot Bloom of Stanford and SLAC goes over the levels of openness or corruption in science. Highly political science is of course the worse. This talk goes over global warming climate “science.” Bloom comes after Soon:

  1. Hi Michael, thank you so much for this blog, I read every entry. I would love to hear your thoughts on the financial derivatives market and how it factors into your analysis of profitability. Is it simply another one of those countervailing factors attempting to hold the falling rate at bay? Do you see its affect on capitalism itself to be more radical than that? Thanks!

    1. Hi Jo. I have looked at financial derivatives in my book, The Long Depression – see the chapter on Debt. Yes, financial derivatives are just that – derivatives of financial assets mainly bought and sold for speculative purposes, adding yet another layer to ‘fictitious capital’. Fictitious capital is partly a counteracting factor to falling profitability in productive sectors, but also opens up a significant risk of adding to the extent of any financial collapse when credit dries up.

  2. Maybe mainstream equilibrium economic models can’t assess cost of doing nothing, which is pretty much BAU. Cost of climate change weather related events is rising exponentially. So much so they will start driving economy into negative territory by mid this decade. As our economic system goes into collapse with negative growth, the unviability of our current growth oriented economy is a given. Our only option to manage it, denial will make it worse.

  3. I posed the following to our state’s environment minister and got the brush off:

    “IN chapter two on page 108 in the SR1.5 IPCC report that came out last year it says that if we are to have a 67% chance of limiting the global temperature rise to below 1.5C, we had on January 1st 2018, 420 gigatonnes of CO2 left to emit in that budget. And, of course, that number is much lower today, as we emit about 42 gigatonnes of CO2 per year, including land use. With today’s emissions levels that remaining budget will be gone within about eight years.” Greta Thunberg addressing the COP 25 Conference on December 12, 2019.

    “We demand that at this year’s forum, participants from all companies, banks, institutions and governments immediately halt all investments in fossil fuel exploration and extraction, immediately end all fossil fuel subsidies and immediately and completely divest from fossil fuels.
    “We don’t want these things done by 2050, 2030 or even 2021, we want this done now – as in right now.
    “We understand and know very well that the world is complicated and that what we are asking for may not be easy. But the climate crisis is also extremely complicated, and this is an emergency. In an emergency you step out of your comfort zone and make decisions that may not be very comfortable or pleasant. And let’s be clear – there is nothing easy, comfortable or pleasant about the climate and environmental emergency.” Greta Thunberg addressing attendees at Davos this week.

    What legislation will be pursued by our WA Labor Party state government to reduce WA’s greenhouse gas emissions to zero in eight years?

    Why is Woodside being allowed to release 200 million tonnes of carbon dioxide for the next thirty years from its Browse Basin project as this will likely blow Australia’s Paris climate targets out of the water?

    Is your government breaching its duty of care?

    Are governments, including yours, legally liable because they are now being hazardously negligent i.e. ignoring their own IPCC and allowing greenhouse gases in the atmosphere to increase?

    1. As an engineer in physics I can tell you that there is no man-made climate change. On the other hand climate changes always and we have to live with that.

    1. As an engineer in physics I can tell you that there is no man-made climate change. On the other hand climate changes always and we have to live with that.

  4. I see the information/disinformation problem as the most central. How will it become possible in a capitalist society to make the population believe in something that they cant see or feel by their own individual selves? And when the climate change reaches so far that a big enough group of individuals can experience it, how are they to reach the conclusion that something should be done? And, most important, how are they to keep that consciousness long enough to get something decisive done in the face of the enormous vested interest in continuing business as usual?
    Am I an pessimist?

  5. The problem with the deniers is this. Their lack of explanation. First, solar output has not risen to warm the planet. “the Sun had just gone through it’s weakest solar cycle, and consequently deepest solar minimum, of the past 100+ years”. Secondly, we are drifting away from the sun not moving closer. “This year, 2019, our perihelion was 1.5 centimeters farther away than it was last year, which was more distant than the year before…” Thirdly, latest research shows that the effect of cosmic radiation, intensified by the dormant sun acting as a shield, has at best only a modest impact on weather. Fourthly, there has been no natural event recently other than more methane leaching into the atmosphere because of global warming, to explain the consistent rise in temperatures. Until the deniers can provide a plausible mechanism other than the tautology it happened before, their observations have to be dismissed. It is as plausible as saying we could be heading for an ice age because they happened before.

  6. Always appreciate these articles, but there is another forgotten and/or ignored problem in this ongoing CO2 debate.

    Atmospheric carbon is not the only threat.
    Soil carbon loss/transference is also posing growing threats, and one that CO2 capture is NOT addressing.

    Nearly 10,000 years of cultivated agriculture has reduced global soil carbon by 116 Gt.
    Numerous Researchers have demonstrated how soil carbon loss/transference has resulted in the collapse of numerous, once thriving civilizations.

    Yes, carbon is a good energy source.
    As such, plants and microorganisms also need that soil carbon for energy to grow & thrive.
    Healthy soils, those that continue to grow truly healthy crops, rely on those microorganisms.

    Most all carbon capture/storage tech doesn’t address or replace the carbon lost on agricultural lands.
    Even plant respiration alone isn’t enough to maintain adequate soil carbon levels (i.e. more is being used.displaced than replaced).

    The “Father of Spin”, Edward Bernays (in his 1928 book Propaganda) wrote:
    “Who are the men, who, without our realizing it, give us our ideas, tell us whom to admire and whom to despise, what to believe…”
    “If you can influence the leaders, either with or without their conscious cooperation, you automatically influence the group which they sway.”

    Indeed, both sides (via the constraints of classic human dichotomous thinking, i.e. polarization) in this ongoing CO2/climate change debate are being exploited by the largest energy companies (such as Exxon, BP, etc.), or more precisely their largest institutional shareholders, to obtain ever-more government subsidies (corporate welfare), just to return ever-greater (but unsustainable) profits mainly to the .001%.

    Yet they are continually creating more & newer problems in the process.

    In this respect, even “activists” like Thunberg are simply serving as mere puppets for those neo-feudal corporate Lords.

    1. Started out as a scam to get tax money and is a form of control. Also, some might have thought it was real decades ago. These two worked together and got in positions of power. Funding then flowed into research and businesses. A trillion dollar industry arose. But for all that investing in solar cells, batteries, wind turbines and so on, has nothing good to offer that would replace fossil fuels. Now it’s hard to go against all that business and funding. Another angle is that superpowers which never intend to go off fossil fuels can hope others will be stupid enough to buy into this nonsense and keep themself economically supressed. After all, why would they want the extra compitition.

  7. Piketty’s new book. Accprding to the bbc, Piketty is back with an updated tome, Capital and Ideology, which comes in at a hefty 1,150 pages. At the heart of it is the idea of “participatory socialism”.
    Mr Piketty advocates incomes and property taxes of up to 90%, a “public inheritance” of £100,000 for every 25-year-old and caps on shareholders’ influence.
    He essentially argues that governments are focusing on limiting the movement of people rather than capital flows in answer to concerns about inequality – saying it is easier to “blame foreign workers” rather than try to deliver a more “complicated” message.

    If that’s his fundamental argument for “participatroy spcialism”, it is laughable.

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