Why an abrupt tightening of climate change policy may be our only hope

To spend time with climate scientists and energy economists these days is to take part in an increasingly tortuous mental conflict. Outwardly, scientists, policy analysts and academics hoping to influence policy must remain positive and optimistic, while keeping a strong sense of urgency. Privately, many are in despair at the lack of progress on cutting greenhouse gas emissions (GHGs) and growing evidence that the climate is already changing faster than expected.

This internal and privately shared pessimism has two separate causes. First, most governments aren’t even hitting their publicly announced policy targets (as in the Paris conference of 2015), and these targets fall a long way short of what is needed to hit the Intergovernmental Panel on Climate Change (IPCC) 2 degree celsius warming limit. (Although people continue to pay lip service to the 1.5 degree target, it seems almost impossible to meet that now).

But these targets are set relative to the IPCC’s existing research and forecasts. Unfortunately the latest research, which will influence the IPCC’s Sixth Assessment Report (AR6) in 2022 (working group contributions to that report will be published in April 2021. The IPCC is a huge network of peer-reviewing scientists, which aims to produce a synthesis of what is known, with varying levels of confidence that are clearly stated, about the world’s climate. Each report has more research to inform it than its predecessor, reducing the uncertainty about various matters such as the risk of key thresholds (e.g. the melting of permafrost leading to tundra methane release) and the speed with which melting ice will raise sea levels.

If the new research was symmetrically distributed between “good” findings, relative to what we already know, and “bad”, then the centre of gravity of the reports and their forecasts would be unchanged, but we would reduce the dispersion of uncertainty around them.

But it seems, from conversations both with Cambridge-based scientists, and with various other academics, that the research is tending towards more pessimistic outcomes. In particular, sea level rises are likely to be higher and faster than originally expected, though there remains a lot of uncertainty still. The Financial Times recently reported that the Dutch Meteorological Society is working on the assumption that sea levels will rise by two metres, even if the Paris agreements targets are met, and by three metres otherwise. This, from the nation with most experience of dealing with the power of the sea.

Those urging greater policy action and urgency from governments, especially the biggest GHG emitter China (27% of the total according to Climate Action Tracker), are forced into the unpleasant prospect of hoping for some kind of cathartic disaster, bad enough to change policy, but not so bad as to hurt too many people. California and Australia have perhaps already had their disasters, in the form of fires that have destroyed lives, property and wildlife. It’s not yet clear if Australia’s policies will change, but the mood certainly has.

The climate “Minsky moment” is coming

So the best that we can perhaps hope for is that, after a few more years of rising emissions, there is an abrupt change of policy in key emitting countries, perhaps leading to a much more determined international effort to get emissions down rapidly. That would be better than business as usual into the indefinite future. But it means a potentially huge shock to the global economy and financial system. Outgoing Bank of England governor Mark Carney has spoken of a climate “Minsky moment”, referring to the work of the economist Hyman Minsky. Minsky identified the moment in each financial crisis when there is a sudden collective realisation that the assumptions on which the boom was based no longer apply, at which point everybody sells, and asset prices then fall rapidly.

The climate equivalent would be investors in fossil fuel companies whose estimated equity values assume a continuing rise in demand into the longer term future, which is what most such companies’ share prices implicitly assume. A radical change in government policy would lead to a sudden fall in fossil fuel demand, a big fall in prices and the bankruptcy of many of the world’s oil and gas companies (note that most oil and gas reserves are owned by national oil companies, which may keep producing for longer as a matter of national policy, but this will further undermine prices.)

The threat to oil & gas values from an “inevitable policy response”

The shock to equity and debt investors could be profound, easily on the scale of the global financial crisis. The excellent carbon think tank Carbon Tracker has just published an analysis of what this might look like, using the term the “inevitable policy response” to describe the sudden change in policy I referred to earlier.

The report is called “Handbrake turn: the cost of failing to anticipate an Inevitable Policy Response to climate change”. (Note, for pedants, that they are using the word anticipate correctly in its meaning of “to act ahead of”). The report models a scenario of “business as usual” demand for oil growing at 0.6% a year up to 2025, then a sharp reduction in demand of -2.6% a year from 2025 to 2040 “halving the value (NPV) of oil projects sanctioned beforehand.”

The effects vary a lot by company, being less for Saudi Aramco for example, as it has the cheapest production costs (and presumably will be the last oil company operating some time later this century after all the others have shut down). The report, by former investment management professionals, is very thorough and somewhat conservative I think. It is in the nature of markets, both financial and commodities, to over-react and lead to greater shocks than might be justified by fundamentals.

Banks, investors, lenders and insurance companies are all exposed to sudden asset price falls. It is unfortunately not surprising to read today in a new report from the Cambridge Institute for Sustainability Leadership’s Banking Environment Initiative that “Many banks continue to take a short-term risk-based (responsive) or CSR (Corporate Social Responsibility)-based approach to climate change.”

I don’t wish any financial or climate harm to anyone but it is getting harder to find hope for early and less costly action, leaving us to depend on the “inevitable policy response” coming as soon as possible.

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