Markets and climate change: A case of cognitive dissonance
Earlier this month, Nicholas Stern — respected U.K. economist and author of the famed Stern Review on the Economics of Climate Change — cast a spotlight on what he calls a “profound contradiction at the heart of climate change policy.”
On one side, the world’s governments have pledged to hold temperature rise to 2 degrees C (3.6 degrees F). To have even a 50/50 shot at meeting that target, humanity has a “carbon budget” of about 1,400 billion tonnes of carbon dioxide between now and 2050. The more we exceed that budget, the more the 2 degrees target slips out of reach. Here’s the thing, though: The world’s proven fossil fuel reserves, if burned, would create about 2.8 trillion tonnes of CO2, double that carbon budget. If countries are serious about 2 degrees, they must be planning to leave a lot of fossil fuels in the ground. Right?
On the other side, however, the world’s top fossil fuel companies are valued at some $7.42 trillion (including the top 100 listed coal companies and the top 100 listed oil and gas companies). They are valued at this level because of proven fossil fuel reserves to which they have access. In other words, their valuation carries the implicit assumption that they will burn the fossil fuels available to them.
Markets are assuming that fossil fuel companies will burn the fossil fuels that the world’s governments have, at least implicitly, said they cannot burn. That’s the “profound contradiction.” So what are markets thinking?
Well, either they think a full-fledged carbon capture and sequestration solution is going to spring into being overnight (spoiler: they don’t think that) or they just don’t think countries are serious about climate change. They think it’s going to be business as usual. “If this is the case,” says Stern …
… the resulting rise in atmospheric concentrations could eventually mean, with a substantial probability, global warming of 5 degrees or more, to temperatures not seen on Earth for more than 30m years. That would probably transform where and how people could live and lead to the migration of hundreds of millions, as well as to conflict and severe economic decline.
Yet markets don’t seem to be pricing those risks either! In fact, global markets don’t seem to be taking climate change or climate policy seriously. Even if you don’t care about that ecologically, it’s alarming economically. It’s a huge, unacknowledged, unhedged risk, and if we’ve learned anything in the past few years, it’s that having huge, unacknowledged risks at the core of your economy is ill-advised.
I was thinking about this “profound contradiction” as I looked over Black & Veatch’s latest “Energy Market Perspective” (they update it every six months), which contains a variety of predictions and projections about U.S. electricity markets. It’s a great example of what Stern is talking about, in microcosm. Here’s the core finding (keep in mind, this graph shows power produced — megwatt-hours — not capacity):
Black & Veatch, Energy Market Perspective, Fall 2011
Renewables more than double their contribution over the next 25 years, mainly due to state renewable portfolio standards, but the big story is the shift from coal to gas, gas, gas. Coal declines from 41 to 16 percent; gas goes from 24 to 44 percent.
Here’s the impact on CO2 emissions (chart is a bit confusing: the green area is the CO2 eliminated by reductions; the other colors are regions of the electric grid):
Black & Veatch, Energy Market Perspective, Fall 2011
Emissions decline, mainly due to a big wave of coal-plant retirements around 2020, but nothing like the amount that would be required under the carbon budget necessary to give the world a chance at 2 degrees. (After all, for large-scale reductions, electricity is central.)
To be sure, there are economic assumptions in B&V’s projections that could be disputed. They have natural gas prices staying low and stable all the way out to 2036, only reaching the highs of the early 2000s after 2030. But with demand rising through that whole period, there are reasons to expect far more volatility than that (see here and here). B&V also has wind deployment falling off after today’s state RPSs are satisfied, but I strongly suspect that underestimates both what states will do in the intervening years and wind’s increasing competitiveness.
But never mind all that. The core assumption, the one B&V shares with most analysts, is about policy. It is simply this: The U.S. is not going to do its part in a global effort to hit 2 degrees.
They don’t assume there will be no climate policy. They include state RPSs and even a carbon price starting in 2020. But as the results show, that level of policy is woefully inadequate.
It’s not that the U.S. electricity system can’t accommodate the level of changes necessary. Amory Lovins’ new book Reinventing Fire shows how to transform the U.S. electricity system at a profit. Or check out Michael Moynihan’s Electricity 2.0. Plenty of other analysts have charted out a course that U.S. policymakers could chart if they got serious. It’s just that mainstream analysts don’t expect them to.
And yet we do nothing to prepare for the future that inaction is going to bring us! It’s a widespread and increasingly glaring case of cognitive dissonance in the institutions and practices at the center of the modern global economy. One way or the other, it’s going to resolve itself, and I fear the results will not be pretty.