What a difference a year makes. Global warming had been dismissed in the business press as the creation of tree-huggers, liberals, and other enemies of free enterprise. Suddenly, it’s a hot cause (no pun intended).
Monday, the CEOs of nine blue chip companies, including General Electric, Alcoa, Lehman Brothers, and Duke Power, joined in the launch of a report by the Climate Action Partnership, a coalition of ten major corporations and several environmental groups. Last night, in his State of the Union address, President Bush recognized “the serious challenge of climate change,” although his proposals focused on energy independence, not greenhouse gases. California’s governor Arnold Schwarznegger signed Assembly Bill 52 last year, which calls for a 25% reduction in greenhouse gasses by 2020, and last week inked an executive order establishing a carbon ceiling for transport fuels. According to the Financial Times, “senators have introduced at least eight bills proposing mandatory limits on greenhouse gas emissions.” Only diehards debate whether human activity is really much of a culprit.
The odd thing, given the high profile it has gotten in the mainstream media and now among politicians, is how little global warming is acknowledged by financial analysts and investors. Oh, to be sure, oil has gone in a remarkably short period of time from $77 a barrel to just over $50 due to weirdly warm winter weather. Alternative energy funds are in vogue (although the dramatic decline in oil prices has dimmed enthusiasm for them). And Barry Ritholtz, in his post “Are Economic Gains Just Hot Air?” mused that the seemingly good economic performance of the last couple of months may simply be weather-related, and activity that would normally occur in March and April has been pulled forward.
But I haven’t seen much in the way of serious thinking as to what climate change could mean for commerce in the long term, say ten to thirty years. Yes, we did have the Stern Review on the Economics of Climate Change. Published in 2006 in the UK, it was a government-sponsored study led by an economist rather than a climate scientist. It concluded that failing to take corrective measures would lead to a fall in world GDP of 5% to 20%, versus a 1% cost of acting now (BTW, those are dramatic numbers). But this study has been the exception that proves the rule. It has gotten little play in the US, particularly among financial commentators. One would expect, at a minimum, for there to be some debate about it. Perhaps the folks who joined in the Climate Action Partnership took its grim conclusions seriously, or did their own analysis.
Let’s consider, on a gross, crude level, what global warming could do to the world economy. Mind you, I did not go looking for the best data, I merely chose some facts from the popular media that seemed to be representative and came from credible sources.
We’ve seen from the bizarre weather this winter that it disrupts growing patterns. The lack of snow in the eastern part of the US may mean droughts this summer. And the lack of snow in Europe has hurt ski areas. Yes, many people and businesses have saved on heating fuel, but it appears for the most part that the gains are diffuse and the losses are concentrated.
Australia has been suffering from abnormal weather for longer than the Northern Hemisphere. Its drought has gone into its fifth year. Initially, the effects were simply markedly higher food prices, and bankruptcies and suicides among farmers. In a BBC interview, Professor Andy Pittman of Macquarie University noted,
The really scary thing is last time we had a drought of this intensity that lasted about five years – it lasted for about 50 years. The politicians truly believe this is a five-year or six-year drought that will break sometime in 2007 or 2008. But it might not break until 2050 and we aren’t thinking in those terms at this stage.
While we are generalizing from two data points, again we see that certain sectors, primarily agriculture, are hit hard in the early stages, while the rest of the economy is largely unaffected.
These are examples of the immediate economic effects of climate change, and they are already creating localized pain. The big worry going forward is that changes may not be linear, but rather sharp and disruptive. The poles are warming at a faster rate than the equator (that’s why the polar bears are having such a hard time). More rapid melting has two effects: it raises the sea level when ice that was on the land melts into the water, and it also reduces the salinity of the ocean, which has the potential to disrupt gulf streams.
A recent New York Times article on the warming of Greenland had some disquieting facts:
All over Greenland and the Arctic, rising temperatures are not simply melting ice; they are changing the very geography of coastlines…
”We are already in a new era of geography,” said the Arctic explorer Will Steger. ”This phenomenon — of an island all of a sudden appearing out of nowhere and the ice melting around it — is a real common phenomenon now.”…
The abrupt acceleration of melting in Greenland has taken climate scientists by surprise….”The general thinking until very recently was that ice sheets don’t react very quickly to climate,” said Martin Truffer, a glaciologist at the University of Alaska at Fairbanks. ”But that thinking is changing right now, because we’re seeing things that people have thought are impossible.”
Until recently, the consensus of climate scientists was that the impact of melting polar ice sheets would be negligible over the next 100 years. Ice sheets were thought to be extremely slow in reacting to atmospheric warming. The 2001 report by the Intergovernmental Panel on Climate Change, widely considered to be an authoritative scientific statement on the potential impacts of global warming, based its conclusions about sea-level rise on a computer model that predicted a slow onset of melting in Greenland.
”When you look at the ice sheet, the models didn’t work, which puts us on shaky ground,” said Richard Alley, a geosciences professor at Pennsylvania State University. There is no consensus on how much Greenland’s ice will melt in the near future…Yet given the acceleration of tidewater-glacier melting, a sea-level rise of a foot or two in the coming decades is entirely possible, he said. That bodes ill for island nations and those who live near the coast.
”Even a foot rise is a pretty horrible scenario,” said Stephen P. Leatherman, director of the Laboratory for Coastal Research at Florida International University in Miami.
Let’s go back to what this means for financial markets. Even if we see concerted government action now, it is going to take some time to change usage patterns. And important players like China aren’t on board. So the best we could hope for is keeping emissions from increasing (and that is likely heroic). And present levels of emissions equates to newly high global temps. So even in an optimistic scenario, it’s not clear how much more melting takes place before we reach a new equilibrium, and how much weather change and other dislocation goes along with that.
We’ve already seen that energy prices have become more volatile. Agricultural output will become more uncertain. There may be famines, but probably in the third world, so that doesn’t count. And we have a possibility of more serious changes, most notably a big enough rise in the oceans to flood coastal areas.
Let’s say there is a 5% chance of a seriously bad scenario in 15 years, and 10-15% in 30 years. And if things get seriously bad in the physical world, it will be similarly bad for financial instruments. Why? The world will have a lot of volatility on a current basis, and huge future uncertainty (or worse, certainty of as bad or worse outcomes). Investors will only be willing to place short term bets, if that. The effect will be similar to that of being in a highly inflationary economy. There won’t be a much of a market for long dated assets, discount rates will be high, and as a result, equities will trade at low multiples.
Why have we heard no discussion of the possible downside and the implications for markets? To give you an illustration, the Financial Times’ Martin Wolf, their award winning lead economics editor, wrote an article in early 2007 that looked at world growth prospects beyond a year. It turned out his focus was not that much further out, say the next 2-3 years, and he concluded the big issues facing the world economy were the savings glut and globalization. With the best thinkers only looking out over the relatively near term, it is easy to dismiss imponderables like global warming that could have catastrophic impact, simply because they won’t show up in their at most five year forecast horizon.
We are led to believe that markets prices reflect the information currently available. Yet ten year Treasuries are trading at a current yield of 4.80% and 30 year Treasuries at a yield of 4.90%. Ten extra basis points for 20 years of risk says that no one is factoring in the risk of global warming. Is this informed skepticism, excessive liquidity, or denial?