Decarbonizing the world: Prospects and challenges for market driven crisis aversion
Sunday, May 31, 2009 at 07:36PM Salutations fellow freedom seekers,
This is KTJ again, back from an unconscionably long hiatus from our good readers here at DP. Thus far we have primarily explored risks to the global economy posed by private financial institutions and central bank policy. We now hope to expend some effort toward elucidating the relationship between the global economic crisis and the global environmental crisis, and to this end we begin here with a brief introduction to the fundamentals of energy commodities, and the emerging carbon market. Given that cheap fossil energy is the mana of economic growth, the nemesis of environmental health, and fundamental to human development, we seek to understand the ramifications of their continued use, evaluate emerging alternatives, and explore the potential regulation and trading schemes under intergovernmental and market driven GHG (greenhouse gas) constraints.
The first steps in this task are delineating the sources of emissions and the different types of emissions, which have already been done for us by the International Panel on Climate Change (IPCC) and the Energy Information Administration (EIA). *Note – Graphs in this post will present data from different years, however they were chosen to reflect as close to an average/baseline scenario as possible for the past 5 years*
Figure 1 can be a bit confusing as it distinguishes “Energy Supply” from “Transport”, “Industry”, and “Residential and Commercial Buildings”. We can infer from this distinction that “Energy Supply” embodies all emissions associated with the procurement and generation of energy sources (i.e. CO2 from gas flares in Nigeria/Persian Gulf/Northwest Russia, methane leaks from coal mining, electricity production via coal and natural gas, etc.), whereas the others measure emissions generated as a result of end user demand for energy supplied. Figure 2 gives approximations of different GHG emissions for the United States in 2006.
For the purposes of this introductory post we will leave all discussions of agricultural, forest-related, and non-anthropogenic sources (e.g. permafrost melt) of GHG emissions for a later date. This year the United States was relieved of its dubious distinction as the world’s largest direct emitter of carbon dioxide as China’s astounding economic growth rates (fueled by American consumerism) correlated to soaring consumption of fossil fuels. Total global CO2 emissions are estimated at between 25-30 gigatons annually, and the total energy released by these fuels is estimated at around 400-420 Quad (quadrillion BTUs).
In the future we will take a deeper look into Chinese energy and emissions flows, but for the moment we will focus our attention on the United States as it is currently the largest consumer of the three most important fuels – petroleum, coal, and natural gas – and these commodities are traded in $USD. Current annual consumption of these resources in the US amounts to:
Petroleum – 7-7.5 billion barrels (bbl) or 18-20 million bbl/day
Coal – 1-1.15 billion short tons (S/T)
Natural Gas – 21-23 million cubic feet (MMCF)
While the US is almost self-sufficient in both coal and natural gas consumption there is a severe imbalance in crude oil consumption as US oil reserves have been in decline since the 1970s and demand continued to grow until 2008 when prices for WTI crude ran up to $147.27 per barrel. The run up in prices coupled with the devastating effects of the Great Credit Catastrophe to create extraordinary demand destruction in the US leading to a subsequent crash of prices and a spike in stockpiles. The plunge in energy and food commodity prices combined with the wave of deleveraging amongst financial institutions has led to the first instance of deflation in the US since the abandonment of the true gold standard, and has led to a perilous situation in which oil and gas rigs have been shut down and investments in new exploration and production cancelled. This deflationary period will actually give birth to its own demise as inflation will begin when money comes into markets from the sidelines and goes into tangibles like short- and mid-term commodity futures for goods with intrinsic value to human civilization.
We have predicted that there will be a dollar crisis as a result of the quantitative easing at the Federal Reserve sometime in the next 1-2 years. However, there are a number of factors which could forestall, or even negate this possibility which we have often referred to as an event horizon. The most important factor that could lead to an aversion of a dollar crisis is a massive reworking of the international carbon market, which is precisely what is going on as markups and discussion on the Markey-Waxman “American Clean Energy and Security Act” (the most important bill you never wanted to read at 648 pages long!) come to a close and the bill prepares to enter the House of Representatives. The likely passage of this bill will have further repercussions on the United Nations Framework Convention on Climate Change which will take place December 7-18 in Copenhagen, Denmark. As has been noted in the discussion forums here, the value of the carbon market has almost doubled annually in spite of the recent crash of carbon prices in both voluntary markets and under the European Trading Scheme.
Given the quantity of emissions produced globally, we believe that the establishment of a global emissions trading facility dealing in Certified Emissions Reductions (CERs) denominated in $USD is the last bastion of hope for the Dollar. We turn our eye now to detailed emissions flow charts (albeit dated) for energy and CO2 emissions in the United States to give you an idea of current pathways and potentials for reductions.
The first thing that stands out from this chart is the whopping amount of LOST ENERGY. Nearly ¾ of all fuel consumed for electricity generation is lost in transmitting electrons and waste heat! Around 80% of petroleum used for transportation is lost due to the incredible inefficiency of the internal combustion engine! Now let’s take a gander at the resulting CO2 emissions:
Again, the largest potential areas of reductions are electricity generation and transportation. Looking at the bigger picture, Mckinsey & Company was smart enough to produce a report back in December of 2007 in which they looked at the costs and potential reductions of a variety of technologies and design improvements, seen here:
Yet again the most seductive opportunities for abatement lay in efficiency which despite some up-front capital costs have enormous returns on investment (ROI) and miniscule payback periods. Insulation, lighting efficiency, and vehicle fuel efficiency together would achieve around 5-6 gigatons of reductions annually. However, as most energy commodities are fungible (i.e. if one consumer abstains then the resultant price decrease will encourage another economic actor to begin to consume or to augment existing consumption) these reductions would have to be combined with penalties (be it a tax or an inducement to purchase some form of offset) in order to assure sustainable and verifiable reductions.
While the possibilities of efficiency and new technologies (like supercritical and ultra supercritical coal plants) may seem like cause for optimism, we must look at the considerable amount of foot dragging that is occurring in implementation as the Markey-Waxman bill exhibits a possible misallocation of attention and resources to nascent (not to mention unproven and exorbitantly expensive) concepts and technologies like carbon capture and sequestration (CCS). The degree of collusion between coal and petroleum producers, utilities, and politicians leads one to wonder whether real progress toward reductions is possible. The prospects depend entirely on the outcome of the aforementioned bills and conventions that aim to overhaul carbon markets and replace them with a more comprehensive and integrated global GHG emissions trading facility. However, the eagerness of Financial Institutions to head into the next adventure in global investing strategies (as seen here) lends weight to the possibility of this bubble getting filled with a lot of hot air. We aim to keep our readers well informed of developments in this arena, as well as to continue exploring other emerging markets for less tangible goods like ecosystem services and water, so stay tuned for our next exploration of global macro-eco-nomics (and please critique, share sources, and contribute if it so please you, we know that many of you out there have experience in this particular arena!).
To the conscious development of all beings,
KTJ
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Reader Comments (10)
KTJ - I am really interested in your notion that a USD-denominated carbon credit market might help forestall the USD-event horizon. I disagree. For starters, I don't believe that the carbon credit market will grow anywhere near fast enough for it to really make a dent in the USD-denominated universe of financial contracts. Usually, people need a motivation to demand a given currency. For example, countries need to buy oil, so they hold dollars as reserves. Trading carbon credits is unlikely to be considered a privilege or a necessity, thus countries wont be hankering to get dollars in order to trade them. Implementation of a global trading scheme is likely to be too slow to matter when the grim reaper comes calling on the USD. One thing I do agree with you is that this nascent derivative market will be increasingly important in the years to come and will likely grow to a very large size (though comparatively to the OTC derivative market, perhaps not as much). What do you think of this?
MAAA, you are quite right and your knowledge of derivatives markets is much deeper than mine. IF both Markey-Waxman passes and the UNFCCC establishes a global GHG trading facility (which by the time it is implemented may well trade in products denominated in SDRs [which could include more stable currencies such as the Chinese yuan, Brazilian real, etc. by then]), there is a possibility of at least dampening if not avoiding a complete collapse of the USD. A possibility does not a surety make, and given the colossal amount of debt out there that is going to go sour you may be right and it is a foregone conclusion. However, given the amount of rhetoric in media and politics currently on climate change, I am inclined to believe that it is *possible* that in the event of a price (let's say $50 USD per ton) is set for CO2 emissions, then potential annual market could reach $200 trillion USD (given 40gigatons of CO2 equivalent emissions per annum). Considering the fact that China and the US are the largest emitters and the have the most to lose with a total devaluation of the US Dollar, it seems that they should be willing to cooperate on a new financial derivative that could amortize treasury and SIV losses. China also has a significant interest in keeping petroleum prices low (which US efficiency would aid enormously) as it will take them some time to advance on electric vehicles and they are quite dependent on cheap petroleum for exports. Do you agree with this logic? I also propose to take a deeper look at petroleum use in the US, which will inevitably look at China as well...
Er, miscalculation, it would reach $200 Billion per annum at $50 per ton. Your point is well taken, the Dollar appears to be doomed.
Very well written KTJ. Two words; Dalton Minimum.
I thought that we had dispatched the idea of a global carbon market forestalling a dollar crisis some time ago. Nevertheless an interesting post. Given the current state of Markey-Waxman and the fact that there is no authority to impose a global emissions tax or cap I find the idea that there will be an average emissions cost of $50 per ton highly unlikely. Some may pay something like that but most will pay nothing at least initially. Furthermore while China has in interest in maintaining low petroleum costs, it has just as strong an incentive to avoid paying emissions cost. I would put the chances that China is going to meaningfully participate in a global emissions regime (meaning that they will compel their citizens to pay for emitting) at less than 1 in a 1000. Europe already has their own emissions regime. If the US creates a dollar denominated market that only governs American emissions it won't create a meaningful increase in dollar demand. I do like to discuss unlikely scenarios so thanks for bringing it up.
CM0101, even if you doubt the relationship between the 33% increase in atmospheric CO2 concentration and global climate change, then there are still other externalities associated with fossil fuel consumption (ocean and reef acidification, methyl mercury pollution, waterway contamination, etc.) that give ample reason for humans to begin seeking to regulate and minimize their consumption. As for a carbon market saving the dollar, Discipulus you make the salient point of the losses that China and the US stand to incur (the traditional argument for US and Chinese failure to participate in the Kyoto Protocol), and indeed such an event would be a black swan. However, as Nassim Nicholas Taleb has shown, black swans do occur, and when they do they have powerful effects.
I interject only to say that black swans are worn and many, I usually call them the FAT DARK WINGS since that is precisely what they look like in a probability distribution. The problem always comes with the initial assumptions in the models rather than an inherent lack of tractability of any given event. I haven't read Taleb's book but we dont need him for proof that black swan events happen all the time.
KOTJ said:
" 33% increase in atmospheric CO2 concentration and global climate change, then there are still other externalities associated with fossil fuel consumption (ocean and reef acidification, methyl mercury pollution, waterway contamination, etc.) that give ample reason for humans to begin seeking to regulate and minimize their consumption"
According to whom? According to what data and according to what sponsored investigative science are we giving credence to? See, there are tons of real issues infront of me that I can either profit from it or help find a solution, trying to figure a problem that perhaps might be colossal or inconsequential in the future is something that my lifestyle does not permit. Don't be fooled by quais-science and the greedy human salesman hand. To me, global warming does not exist, and as far as climate change is concerned the only thing that is constant is change, don't fight it or you will loose.
CM0101, you missed the point of both my post as well as my response to your initial comment. Whether or not you lend any credence to the concept of climate change governments and financial institutions are moving to enact legislation and implement trading mechanisms hypothetically aimed at reducing CO2 emissions to the atmosphere. You would do well to at least look at the table of contents of the Markey-Waxman ACES act as it would entail significant investments in costly technologies such as Carbon Capture and Sequestration (CCS), a technologically and financially unwieldy process that has the potential to add as much cost to every kilowatt-hour of energy that YOU consume as would a cap and trade system for issuing carbon allowances (which the bill ALSO entails). Whether or not you believe the most respected (and peer-reviewed) scientists in the United States, as an investor you should heed trends and observe issue rhetoric. Whether or not you will be directly affected by a stronger storm or a drought in the future, I cannot predict, but to the extent that government policies and resource scarcity affect all economic activity I can tell you with 100% certainty that you would benefit from understanding how such policies will affect macroeconomic trends. My goal is to examine and present the most likely outcomes of such activities and you may ignore me at your own peril.
Owww at you own peril . . . Seriously we are all intelligent adults here. Lets try to keep our own rhetoric in check even if the world goes mad. I think that CMO101 understands that potential government actions in relation to anything market related have the potential to affect macroeconomics. That being said I believe that we are also quite skeptical of the idea that a carbon market is going to do anything to stop superinflation especially in the next one to two years. I would estimate that the chances that such a market will make the difference between superinflation and not superinflation at somewhere around .1%. The principle of the fat dark wings as MAAA calls them is that we need to pay attention to events that we believe to be unlikely but that have enormous consequences. In the short to intermediate term a robust carbon market is both unlikely and does not have an enormous consequence.