An Unfortunate Reality: We Will Not Stop Global Warming
“Just because you do not take an interest in politics doesn’t mean politics won’t take an interest in you.”
— Pericles, Greek Statesman (495 BC to 429 BC)
In 2008, I participated on a panel entitled, “Finance, Energy and the Environment” at the Museum of Finance in New York City. Myron Kandel, the founding financial editor of CNN, was the moderator and posed this last question to the group: “Do you think we will stop global warming in time to prevent the worst impacts?” My response was reasonably upbeat: “It will be hard, but I’m optimistic we can avoid the very bad outcomes for a few reasons — public recognition of the risks has increased, policies to regulate and price carbon have momentum, and capital and talent are flowing to areas such as solar and wind. It is going to be hard but I am optimistic.”
That was then, this is now. Nearly 10 years later, it is clear that global warming will create substantial economic, security, health and environmental problems for many decades to come. While there has been progress with the uptake of low-carbon fuels, worldwide emission rates have trended up, not down. We have crossed 400 ppm of CO2 in the atmosphere and, in just 15 years at current emission rates, levels will be near 450 ppm, a level that poses severe risks to a much warmer planet. The only solution is to regulate and price carbon, but this seems even more unlikely than ever. As such, business leaders, investors and government officials should make global warming — likely the greatest secular shift they will ever experience — their base case for future planning and analysis, not some theoretical “black swan” scenario.
Carbon Has Continued to Increase Unabated and Meaningful Regulation is Unlikely
The headline of this newsletter was carefully chosen, stating we “will” not stop global warming — not that we “cannot” stop it. We, in fact, can stop it, but lack the leadership to do so. What do I mean? Our economic systems are very effective at efficiently producing goods and services if companies bear the total costs that are created when they operate. Yet with fossil fuels, the cost of carbon is not borne directly by those that emit, but rather indirectly by all of society as temperatures increase. Consequently, emitters have an economic incentive to continue to pollute.
This only changes if governments regulate the market failure and ensure the cost of the pollutant is put back to those that emit. If pollution is priced, economic systems are incredibly effective at changing outcomes for the better as the U.S. acid rain regulations in the 1990s demonstrated. But if governments do not proactively act, change will only occur after the public sees the impact with such clarity that they demand action. Unfortunately, this reactionary regulation will be too late. By then, the carbon levels will be so high that the world will feel the negative consequences and, in some cases, the irreversible impacts for many decades to come.
Many will be tempted to push back, citing the growth in low-carbon alternatives such as solar, wind and electric vehicles. These are all very impressive and, as someone who has been involved in the industry for nearly 15 years, been amazing to witness. However, the only data point that matters is the level of carbon dioxide in the atmosphere and, unfortunately, that level is rising and showing few signs of abating (see Figure 1). The only way that level will change fast enough is if there is a concerted, worldwide effort by governments to regulate and price carbon.
The numbers are daunting. NASA scientist James Hansen first warned the U.S. Congress about the risk of global warming in 1988 when carbon levels were 350 ppm. Regrettably, current levels of carbon dioxide are now over 400 ppm and the world is adding +1.5 to +3.0 ppm each year. At current emission rates, the level of carbon dioxide is estimated to reach to reach 450 ppm in just 15 years — making the risk of temperatures rising 2°C very high. Worse yet, warming begets more warming (for example, as glaciers melt, those glaciers no longer reflect sunlight; as such, those areas will absorb more sunlight and thus warm more). James Hansen recently commented on the potential impact of this effect, “…2°C global warming, would spur ‘slow’ feedbacks and eventual warming of 3 to 4°C with disastrous consequences.”[1] Remember, 3 to 4 degrees Celsius is 5.4 to 7.2 degrees Fahrenheit. Once reached, the negative economic, environmental, health and security problems of a substantially warmer planet will be incredibly hard, if not impossible, to reverse.
The core economic problem is that energy and resources are mispriced, not accounting for the cost of the emitted carbon. Politically, it is too hard to fix this market failure, so the U.S. government and others have mandated efficiency measures for certain appliances and automobiles and subsidized certain low-carbon technologies such as wind and solar (it is important to note that all energy is subsidized in various ways). This is an inefficient, non-free market approach, which leads to what I call government-driven supply and government-mandated efficiency. The result is that companies complain that they are forced to make products consumers do not want and lobbyists — not entrepreneurs — are the drivers of economic outcomes.
If we regulated and priced carbon instead of mandating efficiency and subsidizing supply, the entire dynamic changes. As prices increase due to the pricing of carbon, consumers — not government — will demand more efficient appliances and vehicles. Entrepreneurs and investors will form companies and products that will drive efficiency in ways that the government could never imagine. Once clear rules are in place that increase the cost of polluting, talented entrepreneurs and capital providers will form companies and develop technologies to exploit this opportunity. Cleaner and more secure forms of energy will scale exponentially faster in a world where talent and capital strive for solutions than in a world of competing lobbyists. By regulating and pricing carbon, we transition to an economy of consumer-driven efficiency and market-driven supply.[2] There are, however, political and psychological barriers to regulating and pricing carbon which make this scenario unlikely. And if carbon is not regulated and priced, the emissions rates will not change fast enough to prevent global warming.
The Political and Psychological Barriers to Regulating and Pricing Carbon
Acid rain was regulated to great success in the U.S. in the 1990s by regulating and taxing the pollution through a cap-and-trade program. In just 20 years, the pollution was cleaned up as shown in Figure 3 below. In 2003, government officials had proposed similar legislation for carbon (e.g., Lieberman-McCain Climate Stewardship Act), yet there is hardly any traction now nearly 15 years later. Why? The reasons are both psychological and political.
- The problem is not emotional or tangible to most people: It is human nature to react in an emotional versus fact-based manner. This is, after all, why advertisements are focused on striking emotions and not listing facts. Unfortunately, the concept and description of “global warming” can seem academic and intangible to many people, stirring few emotions. Compare this with acid rain where the term alone evokes an emotional response. Tangible evidence, specifically lifeless lakes in parts of the country, made it clear to many how they were being directly and immediately affected. Citizens demanded action, government regulated and priced the pollutants, and then pollution levels decreased in a remarkable way.
- Solving global warming feels like a bad deal: The solution is often framed as bearing costs now (e.g., some sort of tax on carbon) for uncertain gains in the future. This, simply put, is bad marketing — it feels like a bad deal.[3] The framing should be more about preventing great losses that are occurring now, and an investment for greater economic gains and job creation in the future. Reframing the argument is possible as shown in the June 8, 2016 edition of The Economist magazine. In discussing some of the costs of climate change, it said, “Private insurers say that last year was the second most expensive in American history for disaster related to climate change, costing them $139 billion. But private insurance paid only a quarter of the costs, leaving taxpayers to cover the rest. By comparison, funding renewable energy property seems rather cheap.” Unfortunately, this more effective framing of the solution is rare.
- A multitrillion-dollar industry is, logically, against change: If carbon is regulated, the owners of those assets face lower profits. The fossil fuel industry is a multitrillion-dollar industry and one would expect it to push for maintaining the status quo.[4] Acid rain was different in that low-sulfur coal would benefit at the expense of high-sulfur coal. Many low-sulfur coal companies formed “clean coal” lobbying groups and supported the regulation. There is a learning here: the enemy of your enemy is your friend. Renewable advocates would be well-served to show large utilities how the transformation to a low-carbon future might help their business versus hurt it, for example.[5]
- Level of international trust and cooperation needed is daunting: Carbon is much more of a global issue than other forms of pollution such as acid rain where the impacts and solutions were more localized. Given energy is the backbone of many economies, countries have an incentive to use so-called “cheap” fuel to gain a short-term cost advantage as other countries bear the costs of their emissions over time. To be effective, regulations need to be a coordinated worldwide effort, which always promised to be a challenging negotiation. Now, given the Trump’s administration’s rhetoric on trade and aggressive comments toward China, a critical partner for effective worldwide regulation on carbon, progress on carbon seems more unlikely than ever.
Optimists may point to recent news about Republicans supporting a carbon tax (which is simply a means to regulate and price carbon) as evidence of momentum. I applaud the effort, but note that Scott Pyle, the head of the Institute for Energy Research and leader of the Trump’s administration’s transition team for energy, is already on the record against this proposal. Additionally, Scott Pruitt, a climate-change skeptic, now heads the Environmental Protection Agency (EPA). In the face of a multi-trillion-dollar industry standing to lose from regulation, clear statements from the Trump administration against carbon regulation, and the level of international coordination needed to be effective, does anyone really think now will be the time that carbon gets regulated?
Implications for Business Leaders, Investors and Government Officials
Company boardrooms, government halls and investment committees are often hyper-focused on near-term cyclical issues. How is the current business operating? What can be done more efficiently to improve next quarter? However, a myopic focus that loses sight of a looming secular shift is a recipe for disaster. Just ask retailers who were overly focused on their physical stores and paid less attention to the secular shift occurring as people starting buying goods on the internet. That secular shift was the greatest risk they faced, yet many companies missed the risk — and the opportunity — entirely.
We are in the early stages of one of the greatest secular shifts in a generation: the warming of the planet. While the impact of global warming will vary by geography, risks include increased coastal flooding, droughts, severe weather events such as hurricanes, disruptions to food supplies, stress on water systems and heat-related health problems and disease. Business leaders, investors and government officials should be thinking now about what happens as global warming increases in intensity.
Business leaders face not only risks, but opportunities for those that manage well. For example, an engineering and construction firm with a focus on fossil fuels may risk decreased demand over time. At the same time, the company’s expertise may be useful in helping coastal areas prepare for the impact of increased flooding — an opportunity. Supply chains face risks as severe weather impacts physical assets or inputs such as food or water. Those that manage this risk well, however, are likely to build a competitive advantage over less well-prepared peers. For example, Unilever, dependent on water as an input, clearly expects senior management to manage water risk. Senior executives are required to have water risk management plans and performance is measured to agreed-upon goals.
Investors should evaluate where economic value will be created and destroyed as global warming takes hold, and when. As the internet revolution showed, secular shifts present opportunities and risks for both companies and investors. Global warming is trickier given that the secular shift will occur over a longer timeframe. That means cyclical factors can dominate economic outcomes and valuations during many periods of time during this shift. For example, while solar generation has grown tremendously, oversupply of the solar modules that generate the power from the sun led to depressed economics in that part of the value chain. Those that failed to appreciate this dynamic lost a tremendous amount of money. Likewise, some investors have maintained a rigid thesis, such as “we are in a resource-constrained world,” when, during many cyclical periods, resources are more than abundant. Failing to appreciate how and when cyclical shifts can dominate the economic outcomes is one reason that many so-called “sustainability” investors (i.e., those focused thematically on “clean” or “low-carbon” investing) have not been so sustainable as they incur large losses during these periods of time.
Government officials should be evaluating the economic and security risks of global warming. The Stern Report quantified the risks of non-action as, “…equivalent to losing at least 5% of global GDP each year, now and forever. If a wider range of risks and impacts is taken into account, the estimates of damage could rise to 20% of GDP or more.”[6] Likewise, global warming is likely to influence security and foreign policy around the world. For example, the Arab Spring seemingly started when a street vendor in Tunisia set himself on fire. Two years later, countries all over the region were facing political instability. Less reported was the fact that large droughts and heat waves in the Ukraine, Russia, Canada and Australia drove wheat pricing up nearly 100%. In a region where 10% to 40% of income is spent on food, this was a trigger for civil unrest (e.g., pictures from some of the protests showed people waving loaves of bread, indicating one reason for their angst).[7] These situations are likely to increase in the years ahead. As such, governments should at least be preparing for the impacts of global warming even if they are not proactively taking steps to prevent it.
Final Thought
In 2006, Al Gore’s movie, An Inconvenient Truth, was released. It showed how carbon emissions were leading us down a path toward global warming. While this re-energized many people to push for change, 10 years later carbon dioxide levels have increased from 380 ppm in January 2006 to 404 ppm by December 2016. At current emission rates, we will near 450 ppm in just 15 years — a level that many scientists fear will lead to severe economic, environmental, health and security problems from global warming far into the future.
We have the economic system, capital and talent to solve the problem and create a better future than the current path. Unfortunately, the political will to regulate and price carbon is as weak as it has ever been and the time to act is short. Without such regulation, the path to global warming’s worst consequences is clear. This does not mean that we should not try to motivate governments to act. However, in preparing for the future, we should never confuse what we want to have happen versus what most likely will happen.
In short, “an inconvenient truth” has become “an unfortunate reality” — we will not stop global warming until it is too late. The implication? Governments, businesses and investors should be preparing now for one of the greatest disruptions they will ever encounter.
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Michael Molnar Biography
Michael Molnar is the Portfolio Manager and Managing Member at M2X Capital LLC, an asset management firm focused on investing in public equities. He has been involved in the energy, industrials, materials, agriculture and consumer sectors as a hedge fund investor, investment banker and sell-side equity analyst for over the past 15 years. In 2016, he published the book, Decoding the Energy Enigma: Improved Decision-Making on This Generation’s Most Pressing Issue, which applies systems thinking and behavioral economics to important topics in energy.
Previously, Michael was a Founding Partner and Co-Managing Member of Lorem Ipsum Partners LLC, a long/short equity hedge fund focused on the energy, industrial and agriculture sectors which grew to approximately $200 million in assets under management during his tenure.
He was also a Founding Partner of Greentech Capital Advisors where he advised clients on M&A transactions, strategic joint ventures and private capital raises. He served on the Board of Directors and the Commitments Committee, helping the firm to grow nearly 10 times, raise two rounds of capital and expand to three offices around the world.
Prior to Greentech Capital Advisors, Michael was the lead equity analyst for the U.S. alternative energy and coal sectors at Goldman Sachs. At Goldman, he also helped to start the Small and Mid-Cap Research Team and was a member of the Special Situations Research Team.
Prior to Goldman Sachs, Michael was a Visiting Research Fellow at Accenture’s Institute for High Performance Business, a company-sponsored think tank. His research focused on management techniques to most effectively maximize shareholder value and was published in both internal and external business journals. He was also a manager in Accenture’s strategy consulting practice.
Michael received an MSc in Decision Sciences with Merit from the London School of Economics, an MBA in Finance from the University of Chicago, and a B.S. in Accounting with Honors from Rutgers University. He is a CFA (Chartered Financial Analyst) charterholder and is a former CPA (Certified Public Accountant — inactive), CMA (Certified Management Accountant — inactive) and CFM (Certified in Financial Management — inactive).
He can be reached at michael@M2Xcapital.com.
Disclaimer
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References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as a recommendation to purchase or sell such securities. The contents hereof should not be construed as investment, legal or other advice. Where information provided in this document contains forward-looking information including estimates, projections and subjective judgment and analysis, no representation is made as to the accuracy of such estimates or projections or that such projections will be realized.
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Copyright 2016 by M2X Capital LLC. All rights reserved.
[1] Assessing “Dangerous Climate Change”: Required Reduction of Carbon Emissions to Protect Young People, Future Generations and Nature, James Hansen, Pushker Kharecha, Valerie Masson-Delmotte, Frank Ackerman, David J. Beerling, Paul J. Hearty, Ove Hoegh-Guldberg, Shi-Ling Hsu, Camille Parmesan, Johan Rockstrom, Eelco J. Rohling, Jeffrey Sachs, Pete Smith, Konrad Steffen, Lise Van Susteren, Karina von Schuckmann, James C. Zachos.
[2] These dynamics are mapped in detail in my book, Decoding the Energy Enigma: Improved Decision-Making on This Generation’s Most Pressing Issue, 2016.
[3] Researchers have shown that people weight losses twice as much as gains (loss aversion) and irrationally value the present versus the future (hyperbolic discounting).
[4] For example, see the leaked memo of Frank Luntz, Republican Strategist and communication expert, which is available online in its original form. He discusses how to thwart the public’s view on climate change, detailing what words and comments would likely skew public perception the most and lead to inaction (i.e. maintain the status quo).
[5] For example, the Edison Electric Institute has commented that, “Against the backdrop of slowing growth in the electric power industry, bringing electricity to the transportation sector is a huge, albeit long-term opportunity for load growth.”
[6] Nicolas Stern, Stern Review: The Economics of Climate Change, released to the Government of the United Kingdom on October 30, 2006.
[7] Arab Spring and Climate Change Report, Center for American Progress
