The Age of Wisdom?

The need to address climate change is going to transform entire industries, our infrastructure, and our lifestyles. But will this transformation be driven by wise policy, oil depletion, or a real climate crisis? Will it be a benign process that creates new jobs and technologies and leaves our societal structures intact, or will it cause violent economic and social disruption that threatens the fabric of democratic societies?

This week’s global release of the climate change docudrama The Age of Stupid has Pete Postlethwaite, apparently still alive and well in 2055, playing the custodian of an immense Noah’s ark of Earth’s cultural artifacts as climate change ravages the earth. Apocalyptic visions of a future beset by high cost oil and climate change are not new, of course. M. King Hubbert predicted in 1956 that oil production would peak in the United States between 1965 and 1970, and Colin Campbell has brought mainstream credibility to the concept of peak oil through papers and 2004 book The Coming Oil Crisis. James Howard Kunstler’s 2005 “The Long Emergency” provides a compellingly gruesome account of the collapse of civilization.

Just last week I heard Christopher Steiner, author of $20 per Gallon: How the Inevitable Rising Cost of Gas Will Change Our Lives for the Better, interviewed on WBUR,  my local NPR station. Steiner, a writer for Forbes magazine, trained as a civil engineer at the University of Illinois, before graduating from the Medill School of Journalism at Northwestern University. His book is premised on the “peak oil” hypothesis, that global oil production will soon start to decline as existing fields deplete and new discoveries fail to keep up. Combined with exploding demand in China, India, Brazil, and other parts of the developing world, fuel prices could rocket towards $20 a gallon for gasoline. His book examines what the world would look like at various price points along the way. Though highly speculative, it’s an interesting thought experiment and a challenge for long-term corporate strategic planning.

Steiner’s conclusions are provocatively shocking. At $8 per gallon, commercial airlines become extinct, replaced by high-speed rail, teleconferencing, and the rebirth of oceanic ship travel, only now its nuclear-powered. When prices rise further, suburbs, exurbs, and their concomitant SUVs and McMansions disappear as people flee energy intense lifestyles and move back to cities to enjoy apartments, trams, subways, biking and walking. Walmart’s business model is dead, because it’s premised on people driving the freeways to huge box stores outside major cities. Plastics derived from petrochemicals become too expensive for consumer goods. And on the supply side, value chains stretching around the world become untenable, leading to drastic restructuring of world trade, production, and sourcing.    

For investors already battered by the current recession, the message seems to be that it will soon be time to go to cash. Indeed, if civilization is really about to collapse, then perhaps even government backed cash and bonds are not safe, and a copy of The Complete Worst-Case Scenario Survival Handbook might be a better investment. While most of the apocalyptic books and movies try to sweeten their message with a modicum of hope, what they lack is nuance.

For business and policymakers who understand the need for a radical low-carbon transition (still by no means the consensus view), a key question is: What will drive this transition? Will it be oil running out pushing fuel prices to stratospheric levels? Will it be a sudden manifestation of climate change that precipitates dramatic governmental economic intervention reminiscent of wartime? Or will wise government policy be able to steer a safe course through the treacherous shoals and avoid the more cataclysmic effects of climate change, resource depletion, or economic depression? It’s important to distinguish the various scenarios, because they have very different implications.

1. Oil Depletion Drives Fuel Prices

This scenario, described by Campbell, Kunstler, and Steiner, points to oil depletion and soaring fuel prices to drive a transition to a low-carbon economy. Oil prices are certainly one of the most powerful drivers of consumer behavior and business investment in low-carbon technologies. As oil prices surged past $140 a barrel in 2008 we saw a dramatic shift in demand toward smaller cars and hybrids and a surge in interest in clean energy from traditional industry and venture capital. Funds that track clean energy such as QCLN, based on the CleanEdge index, and Invesco Powershares’ ETF PBW, joined the bandwagon. Although oil prices have plummeted since the onset of the financial crisis, a  Financial Times article last week predicted a renewed demand crunch by 2014, despite massive new offshore oil finds in near Brazil, Ghana, and Sierra Leone.

One way to understand $140 a barrel oil is in terms of the equivalent carbon price. Burning of a barrel of oil leads to an emission of about 0.12 tons of carbon, so from current prices of around $70 per barrel it would take a carbon price of $600 per ton. The work by McKinsey has estimated (see earlier post Whacking the MAC) that carbon prices of $100/ton CO2e could make a range of abatement technologies viable to reduce US GHG emissions by about 3.5 Gigatons a year by 2030, a reduction of about 1/3 from the business as usual case.  So an oil price of $140 per barrel would send a very powerful price signal to industry and consumers.

Yet there are reasons to doubt the desirability and efficacy of this path. First, oil prices of $140 per barrel produced gasoline prices in the $4-4.50 per gallon range in the US, high enough to shock and anger American consumers, but still far below the $6-9 a gallon Europeans have been paying for a while. Yet as a frequent visitor to Europe, I’m always struck that the roads are choked with ever increasing traffic, even if the cars are smaller and more than half are diesels. Fuel prices alone are not going to revolutionize our use of energy. They are far too volatile to be strong, reliable signals for business investment, and the industry response time at the scale needed is far too slow.

Second, oil prices are increasingly irrelevant for the power sector, which accounts for about 1/3 of GHG emissions in the US, and around 25% worldwide. Liquid oil-based fuels are important for transportation, but the world generates electric power mostly from coal, gas, nuclear power, and a sliver of renewables. There is enough cheap coal for fifty years at least, and nuclear power is expensive but stable in price. Natural gas prices initially jumped along with oil, but vast new discoveries off of Australia and elsewhere, together with the development of unconventional shale gas, will help keep prices reasonable.

Third, high oil prices are likely to be self limiting due to fuel substitution effects. Compressed or liquid natural gas can quite easily replace gasoline in cars and buses and costs the equivalent of about $2-3 a gallon. At oil prices over $60 a barrel, vast reserves of tar sands and bituminous oil shale become commercially viable, if environmentally hazardous. At prices over $100 a barrel, coal-to-oil and biofuels look attractive.

Finally, oil prices that stay above $100 for long are likely to trigger another global recession as money drains out of the US, Europe, Japan, and China. Global oil consumption is about 30 billion barrels a year, so a $100 price increase transfers $3 trillion a year out of consumers’ pockets to exporting countries. The current recession, which was exacerbated by the run-up in commodity prices in 2008, has caused the carbon price and interest in clean energy to slump again. It’s also caused a significant fall in emissions. The International Energy Agency (IEA) projects in a New York Times report that global GHG emissions will fall by 2.6% in 2009, while US emissions, which fell 3.8% percent in 2008, are likely to fall a further 6% in 2009. While good news for the climate, a massive recession is hardly a long term solution for the planet; the fall in emissions could even lead to complacency. Moreover, an oil boom-bust cycle is not only painful but unlikely to generate the sustained investment and enthusiasm needed for a transition to a low carbon economy.

2. Climate Shocks Drive Societal Response

If high oil prices are not going to shift us into a low-carbon economy anytime soon, then perhaps we’ll have to wait for climate change to shock us into action with floods, drought, and the other horsemen of the climate apocalypse portrayed in the movie The Age of Stupid. It’s unclear exactly how bad things have to get before countries are willing to collaborate on real action rather than argue about protectionism or who-goes-first. For anyone who follows the science, the debate is over. Perhaps the best we can hope for is a substantial but non-catastrophic wake-up alarm, a climate Pearl Harbor, such as a big chunk of Greenland ice suddenly breaking off (OK, bigger than the last chunk!). Groups like the Apollo Alliance have called for mobilization of vision and resources comparable to the Apollo program of the 1960s, but the financial crisis has demonstrated that it takes an imminent crisis to spur action on the trillion dollar scale.

Unfortunately, if we wait till the effects of climate change reach crisis levels, the governmental response is likely to be draconian and authoritarian. After Pearl Harbor, governments took over control of factories and ordered production lines switched from consumer to military output. If climate change really does result in massive food shortages and migration, governments are likely to intervene directly in the supply of basic goods and services, and the military and security apparatus of states will be stretched to the limits. International resource conflicts seem unavoidable. While it’s true that some businesses can prosper in times of war and crisis from juicy governmental contracts and monopolistic conditions, this is not a very appealing scenario for the majority of citizens or businesses.

3. Science and Economic Analysis Drives Precautionary Climate Action

If we cannot rely on oil-driven market mechanisms and don’t want to risk waiting for the impacts of climate change to reach crisis proportions, then we have to act on the best scientific evidence and economic analysis that we can – and from the IPCC assessments to the Stern report, it’s clear that aggressive action is needed soon. A strong policy framework for cutting emissions at least 50% by mid-century is needed if there is to be a reasonable prospect of a manageable and orderly transition to a low-carbon economy.  Yet today, as 100 heads of state gather in New York for a UN climate summit, prospects for a meaningful agreement in Copenhagen look dim. Let’s hope this is the age of wisdom.

(reprinted from David's blog Climate Inc.)