Climate Change and the Role of Investors
We’re going to have to do something about climate change.
I will review the science and the possible solutions, and ask what role investors – including your clients – can and should have to foster a solution.
We’ll have to adapt to it. It will continue. It will get worse. We can’t stop it in its tracks. Oceans will rise. We’ll build sea walls. We’ll move away from seacoasts. It will get hotter. We’ll use more air conditioning. That will make the problem worse. Other things will happen. Some of them might be more serious. We can’t be sure which. There are too many complicating factors.
We’ll have to “mitigate” it too. That means we’ll have to stop increasing greenhouse gases in the air. Why? If we don’t the earth will eventually become like Venus. Venus has an atmosphere that is mostly carbon dioxide, the main greenhouse gas. The temperature on Venus is 880 degrees Fahrenheit. We don’t want that. It would take thousands of years to get there if we keep sending fossil fuel emissions into the air. But the earth would become uninhabitable for humans long before that. Perhaps much sooner than we think.
That is the basic science. When greenhouse gases in the atmosphere increase, they slow the release of heat from the earth. The incoming energy from the sun will build up and won’t be released fast enough. The earth will heat up.
Science, therefore, answers the question of whether we need to do something about climate change. Science says yes.
Does science say when we need to do something about it? That’s a question for cost-benefit analysis. Cost-benefit analysis is not science. When somebody tells you, “Science tells us we need to reduce our carbon emissions to zero by the year 2050,” you reply, “Like hell it does.” If the impending disaster were an asteroid bound to hit the earth in exactly 50 years, then the science would say when. In this case it doesn’t. It leaves that to us.
It does say we need to do something. And very soon. But there is no fixed date.
Nobody denies the science of climate change anymore, except those – and there are still many – who are ignorant of it. Nor that something needs to be done about it. What they’re debating is when and how. And even, perhaps, whether something will be done about it without our even trying.
We’ll come back to the debate about when later. It’s at the heart of the problem. But the terms of that debate haven’t been made clear enough.
Let’s talk about howi
Figure 1 shows all the options. Figure 1 is as complicated as we’ll get.
Figure 1. Hierarchy of climate change solutions
What’s “CO2e”? CO2 is carbon dioxide. It’s the main greenhouse gas. It accounts for 82% of greenhouse warming.ii But there are a few other greenhouse gases– methane and nitrous oxide, for example. They also slow the escape of heat from earth. But they slow it at different rates over different times. Their potential to warm the earth is measured relative to carbon dioxide, in units called “carbon dioxide equivalents” or CO2e.
The two main solutions are adaptation and mitigation. We already talked about adaptation. It’s obvious. If oceans rise, we move away. If it gets hotter, we try to stay cooler. If hurricanes get stronger, we protect against them better. These cost money. Worse things could happen. We’ll figure out how to adapt to them as they come – we hope.
The third solution is geoengineering. It includes all the ways we could slow the inflow of solar energy to the earth. It’s to try to make the inflow no greater than the outflow that’s been slowed by greenhouse gases. Geoengineering includes things like spraying sulfur dioxide into the air to screen out the sun’s rays. It includes monkeying with clouds so they reflect more sunlight. Nobody wants to do this. We don’t know the unintended consequences. It could lead to “geoengineering wars,” in which one country causes cooling while another responds with warming. But we need to keep the option open in case a real catastrophe occurs.
That leaves the big solution: mitigation.
Mitigation includes two solutions. Both are ways of keeping the “carbon” (by which we mean all greenhouse gases) out of the air.
One is to suck the carbon away and store it somewhere. This is called carbon capture and sequestration. It can be sucked from the emissions from a fossil fuel-burning plant. Or it could be sucked directly from the air or ocean.
The other way is to stop emitting it.
Let’s talk about carbon capture and sequestration first.
It’s been proposed to grow trees. You can get “carbon offsets” (credit for reducing CO2) by growing trees. Planting four trillion trees all at once would absorb, while they’re growing, all the CO2 emitted in the world. But it would use 12 million square miles of land – more than three times the area of the United States. It would compete with agriculture. It would stop working when the trees mature in about 25 years. What would we do then? This can be part of the solution, but a small part. It’s not a permanent solution. It would help only a little and only for a while.
It’s also been proposed to change the way we farm so it sequesters CO2. This is feasible. But it’s also time-limited because the soil will become saturated with carbon in 10 to 100 years. It could be a small part of the solution – at most 5% to 10% of it – but not a permanent one.
We could doctor the ocean with chemicals, like iron, to cause more photosynthesis and organic growth. This is possible. It could have vast potential because the oceans have enormous volume. When the organic matter dies it could drop to the bottom and store the carbon for a very long time. But it’s only in the beginning stages of research. We have no idea whether it will work on a large scale, what it would cost, and what the unintended consequences might be.
We could use technology to suck carbon dioxide right out of the atmosphere. This is possible. The technology exists. But it’s very expensive. Some recent estimates are about $800 a ton of CO2 removed. Maybe there will be breakthroughs. Maybe it will get much cheaper. But not yet. After all, one of technology’s greatest achievements, the Haber process, was invented to suck nitrogen out of the air. It helped us to synthesize fertilizers, enabling the Green Revolution. The Green Revolution allowed the world’s population to grow without starving. If we could pull nitrogen out of the air, why not carbon dioxide? The air is 78% nitrogen. There’s a lot of CO2, but the air is only 0.04% CO2. It’s much easier to get nitrogen out of the air than carbon dioxide.
Sucking CO2 out of the air or the ocean, looks, at least now, like only a small part of the solution. And probably not a permanent one. But if people are truly serious about goals like “net zero by 2050,” then we’ll have to do at least some of it, because there are some emissions we won’t be able to stop.
One big hope for carbon capture and sequestration is CCS, or carbon capture and storage. It means directly capturing the CO2 from the emissions of fossil fuel-burning plants, compressing it to a liquid, and injecting it in geological formations deep underground.
The nice thing about CCS is it would let us keep using fossil fuels. We wouldn’t have to change things that much.
The world now uses about 17 billion tons of fossil fuels a year – coal, oil, and gas.
But burning them emits 33.1 billion tons of CO2.
You may ask, how can it emit twice as much CO2 as it burns fossil fuels?
It’s simple. CO2 is carbon plus two oxygen atoms. The oxygen atoms are pulled out of the air when the carbon in the fuel burns. The oxygen that came from the air comprises 73% of the CO2. If we do CCS, two-thirds of what we’ll be burying will be oxygen from the air.
If we were to solve the problem by using CCS, we’d have to liquefy and store deep underground 33.1 billion tons of CO2 a year. There are pilot projects to do it.
Where do we stand with these projects?
The total capacity of CCS in operation is less than 40 million tons. It’s less than a tenth of a percent of today’s emissions. We’ve got a long way to go. Some people will object to having CCS in their backyard. It’s already happened. All the federal states in Germany have rejected it. They’re afraid the CO2 will escape. Research will continue, and It should. But it’s not known how well it will scale up and what it will cost. Or whether the public will accept it.
Do any of these carbon capture and sequestration options look like the solution, or even a big part of it? Not now, not with any certainty. We need to keep doing research on them.
The big hope
This leaves the big hope, stopping the flow of greenhouse gases into the atmosphere by “decarbonizing” the economy. That is, by stopping emitting greenhouse gases.
How do we do this? The world runs on energy. Most of our carbon emissions come from burning fossil fuels to produce energy. The only zero-carbon-emitting sources of energy are solar, nuclear, and geothermal. Energy from the sun; from splitting or fusing atoms; and from heat deep underground. (Tidal energy comes from the moon’s gravitational energy, but there’s little of that, and the potential for geothermal energy is very small.)
Solar energy includes wind, hydro, biomass, and waves. They all derive their energy from the sun. Solar energy can’t be used directly, except to get a suntan or raise crops. It needs technology to convert it. The most efficient conversion technology is to convert to electricity using solar arrays, wind, or hydroelectric power. Hydroelectric power can’t be expanded much more than it is now, so that’s a limited option.
The most efficient way to use nuclear energy is also to convert it to electricity with a by-product of heat.
Hence, the most efficient way to use zero-carbon-emissions energy is to convert it to electricity. Any other way to use solar or nuclear energy is less efficient.
That’s why you may hear that the best way to achieve zero carbon emissions is to electrify everything.
This means that in the future almost all transport will have to be electric-powered. Transport that can’t do this, like airplanes, will be powered by fuels that can be created by electricity, like hydrogen made from water by electrolysis. All buildings will be heated and cooled by heat pumps.
Only a sixth of all the energy used in the United States is electricity. If the U.S. energy system is to be decarbonized in 30 years, as some advocate, electricity production will have to increase by a factor of six. And it will all have to be solar, nuclear, or geothermal.
And there will have to be enormous amounts more energy storage, because solar and wind don’t produce electricity when it’s needed. The electricity may be stored in batteries, which are very expensive.
And we’ll need a lot more high- and lower-voltage distribution lines.
The cost of doing all this could be $20 to $30 dollars or more. It won’t work if it meets with too much, “not in my back yard” (NIMBY) resistance. The nuclear, wind, and solar power generation in the U.S. is about a twentieth of what will be needed.
In short, a daunting challenge confronts us.
The United States has mounted this kind of effort before, during World War II. It became more productive than it believed possible. That wave of productivity continued through the 1950s and early 1960s.
Can we do that again?
The hopes for that kind of surge in productivity to solve the climate change problem are being placed on aspirations, goals, targets, disclosures of “carbon footprints,” and pressures to do the right thing. The pressures are to get others to do the right thing, to aspire, set targets, disclose, and pressure others to do the right thing – such as the companies in one’s investment portfolio.
Some of the key participants in this effort to do the right thing are organizations of institutional investors. There’s an alphabet soup of these organizations, such as Climate Action 100+, consisting of five partner organizations (Asia Investor Group on Climate Change (AIGCC), Ceres, Investor Group on Climate Change (IGCC), Institutional Investors Group on Climate Change (IIGCC), and Principles for Responsible Investment (PRI)) and The Investor Agenda, consisting of those five plus the Carbon Disclosure Project and the United Nations Environmental Program (UNEP) Finance Intitiative.
A concert of committed and prominent people and organizations striding arm-in-arm to aspire to zero-carbon emissions, to set zero-carbon targets, to pressure others to set them, and to disclose their progress, could result in inspiration enough to kindle the will to fight climate change.
But it’s not the solution itself. As to whether it can engender that solution, the record is not fully encouraging.
Pressures and commitments to fight climate change have been underway globally since the Rio de Janeiro Earth Summit in 1992. More heads of state were present at that conference than at any other conference in history. It was a big deal. At the Earth Summit the participants agreed to form the UNFCCC, the United Nations Framework Convention on Climate Change. They agreed to meet regularly in a series of meetings called “Conferences of the Parties,” or COPs, to hammer out the details. The next one is COP26, scheduled in Glasgow in November.
The most noteworthy COPs were COP3 in Kyoto, Japan in 1997 and COP21 in Paris in December 2015.
At COP3 the participants agreed to the Kyoto Protocol. The Kyoto Protocol committed 36 of the largest emitting countries to binding emissions reduction targets over the period 2008-2012.
How well did the Kyoto Protocol work? The best way to evaluate it is to look at the Keeling curve (Figure 2).
Figure 2. The Keeling curve
The Keeling curve measures the concentration of carbon dioxide in the atmosphere. It was begun by Charles David Keeling, a researcher at the Scripps Institution of Oceanography. He started to measure atmospheric carbon dioxide concentrations at the Mauna Loa Observatory in Hawaii in 1958.
The annual fluctuations are because of the seasonal variation in growth and decay of vegetation in the earth’s northern hemisphere, where most of the land mass is.
Did we see any reduction during the years 2008-2012, the period when those major emitters committed to reducing their CO2 emissions? It is not discernible. There’s only a steady and even accelerating growth in emissions.
There are many reasons why the Kyoto Protocol caused no apparent change in CO2.
But it served as an object lesson for the designers of the Paris Agreement adopted at COP21 in 2015. Instead of trying to impose binding requirements to reduce emissions on the countries that are parties to the agreement, it let each of them propose its own emissions. Their emissions reduction plans are called Nationally Determined Contributions or NDCs.
The Paris Agreement proclaimed a goal of limiting global warming to below 2 degrees Celsius, preferably 1.5 degrees.
How well would the combined NDC plans, if realized, meet the goals of the Paris Agreement?
Figure 3 gives you an idea. The aspirations are ahead of the reality. The combination of the countries’ commitments to reduce emissions add up well short of the targets.
Figure 3. Projected path of emissions reductions given NDCs compared to temperature reduction targetsiii
It is because of these failures that a teenager was able to stand before an assembly of the United Nations, at the sheepish invitation of the global elites, and declare, “How dare you!”
Nevertheless, some recent signs are positive. In the 21st century a commercial collaboration between European nations – notably Germany – and China has vastly reduced the cost of solar panels. Solar and wind subsidies created a massive number of orders. This induced China and other manufacturers to innovate to drive costs way down.
Does it make sense for institutional investors to lead the way to setting targets and resolving to meet them? They have proven themselves masters at setting goals that were not achieved, then explaining why they weren’t achieved or moving the targets. This is what has happened with climate change.
This leads us back to the when question.
The when question
The answer, to paraphrase Albert Einstein, is: As soon as possible, but not sooner.
Setting goals and targets that will not be met could be counterproductive. It may already have been.
The when question is answered by how fast we can develop and improve the science and technology needed to solve the problem.
In other words, it depends on the rate of return on investment in science and technology.
Economists try to measure the “social cost of carbon.” By this they mean the value of the damage done by a ton of carbon emissions. They think a tax should be levied equal to this social cost. This is a good idea. We should do it.
Economists try to estimate that cost and what that tax should be.
Most of the damage will be done in the future. The economists predict the cost of the damage in each future year. This would be the cost if we don’t do anything about it. It’s called the “business as usual” or BAU scenario. They project this for an unholy number of years, to the year 2100 and beyond.
Nobody thinks you can count a cost in the year 2100 the same as a cost now. The economists have to discount it.
The proper discount rate is a huge point of contention among economists. One faction thinks a low discount rate, about 1.4%, should be used. The other thinks the higher prevailing long-term interest rate should be used.
It makes a big difference. The high discount rate gives you a low present value of the damages. It therefore gives you a low social cost of carbon and a low tax. The low discount rate gives you a much higher one.
If the discount rate is low, the tax is high and the incentive to do something quickly is strong. If it’s high the incentive is to move more slowly and deliberately.
The terms of the argument couldn’t have been designed better to produce no agreement.
One faction of economists says you shouldn’t count future generations as less valuable than our current generation.
The other faction says that we’ll be richer in future generations and more capable of dealing with the problem.
But “richer” how? If we’ll be richer because we have more social media apps or more fintech it’s not going to help much.
What the advocates of a higher discount rate mean or should mean, but don’t say clearly enough, is that if we invest in science and technology to promote innovation to create climate change solutions, we’ll have better solutions later.
But if we spend all the money on pushing only the solutions we have now, we’ll spend too much, and it won’t solve the problem as well.
Thus, it comes back to the perennial big question about the damage done by human technology. Can we develop technology to solve the problems that our technology has wrought faster than we cause them?
We don’t know the answer. We only know that the record shows that for 50 or 100 or 200 years or so, we have done it.
To hedge our bets, we should do both. Push to install carbon-free electricity now, as some of the world is doing.
But also invest very heavily in research, development, and demonstration of new and improved carbon reduction technologies.
This includes advanced nuclear technologies, especially small modular reactors; improved and lower cost ways of storing energy for later use; technology and incentive pricing schemes to help increase energy efficiency and shift demand to coincide better with supply; electricity grid designs that enable electricity to be moved from locale to locale to meet demand; improvements in solar and wind farm designs and reductions in costs; scaled-up prototypes for carbon capture and storage; research on ways to pull carbon out of the air and oceans; and so on.
What is the rate of return on such R&D? Isn’t that the discount rate economists should use?
There may be some data on that. The economists that use a higher discount rate argue that it’s the prevailing interest rate. This is debatable. That interest rate brings capital for social media apps and fintech, which won’t help.
But what if the potential catastrophic scenarios are so bad that we need to solve it very quickly at high cost – like buying disaster insurance – even if they’re unlikely, and even if we don’t know what those scenarios might be?
Yes, it is important to consider the precautionary principle. Do we need to act precipitously to avoid a potentially civilization-destroying catastrophe, even when there is no scientific certainty of it yet?
If the catastrophe will occur at a specific future time, like an asteroid predicted to hit the earth in 50 years, the precautionary principle would be mandatory.
But climate change doesn’t quite fit that picture, not yet. We may need just a little more science. The potential disaster scenarios are not clear enough yet. For example, we need more research on whether methane will be released from permafrost, triggering a warming spiral if the temperature goes above a certain level.
Resolving up and down to act and pushing others to resolve to act is not the same as acting. This problem needs action, soon. Much or most of that action needs to be massive funding, mostly by governments but also by corporations and philanthropists of the development of science and technology to slow climate change. This is what the institutional investor groups should be advocating.
Economist and mathematician Michael Edesess is adjunct associate professor and visiting faculty at the Hong Kong University of Science and Technology, chief investment strategist of Compendium Finance, adviser to mobile financial planning software company Plynty, managing partner and special advisor at M1K LLC, and a research associate of the Edhec-Risk Institute. In 2007, he authored a book about the investment services industry titled The Big Investment Lie, published by Berrett-Koehler. His new book, The Three Simple Rules of Investing, co-authored with Kwok L. Tsui, Carol Fabbri and George Peacock, was published by Berrett-Koehler in June 2014.
i How is covered in greater detail in Bill Gates’ superb book, “How to Avoid a Climate Disaster.”
ii The warming it causes also brings formation of more water vapor, which is also a greenhouse gas.
iii From a presentation by David Saddington based on data from “UN Global Emissions Gap 2019.” See also Carbon Brief 11-16-2019.