November 26, 2011

Is Climate Change The Next Global Catastrophic Tail Risk?

By Andrew Butter

As the Durban Climate Change conference wheezes into obscurity with memories of a bunch of what the neo-cons call “balding ex-hippies” on one side; and a stack full of conveniently newly-leaked e-mails on the other…and America conspicuously absent, I am reminded of previous catastrophes.

Of other times when all the world’s wise men assured us that there was only a 1% probability of disaster. That’s the chance that within the next 100-years small increases in global temperature might trigger the melting of the permafrost, which would create a feedback loop by releasing frozen methane, which would dramatically increase global warming which would melt the on-land ice-caps, which would mean that sea-levels rose 10-meters, which would mean that 35% of the world’s GDP was underwater, and that’s not counting that 95% of the ports in the world would be underwater, so 85% of world-trade would stop.

But don’t worry, that’s just alarmists talking; everyone knows that’s never going to happen. Except, hang-on, just a second, now where did I hear that word “underwater” before?

I got it…it’s coming…oh yeah…I remember!!

Remember when the wise-men in Moody’s and Fitch and Standard & Poor all worked out that the probability house prices in USA would NOT go on going up forever, was precisely equal to the chance of a collateralized debt obligation lovingly crafted by Goldman Sachs and proudly displaying the (then) coveted AAA quality-stamp on one rump, and a flag-decal saying “Made in America with Pride” on the other one, defaulting?

And now, 35% of the houses in USA are…“underwater”!!

That a branch of the United Nations is incapable of doing anything right is no surprise, that’s an organization where non-democratic governments and crony-dictatorships send their fool-nephews to learn how to steal…they send the smart ones to do internships at Goldman Sachs and Moody’s.

So, the mighty conclusion is that it will get hotter in some places, cooler in other places, there will be more rain in some places and more droughts in other places, and more storms and hurricanes in some places, and more balmy-skies in others, and the sea “might” rise 300mm in 100-Years (that’s a foot if you are American).

Oh my, hold the train, I’m going to vomit…does anyone care!!

I remember, twenty-five years ago, designing a land-drainage system for a smart Big Name “international” engineering consultancy. I got handed down a report that said the sea-levels might rise 300mm during the design life (50-Years), so that’s what I designed for.

The system cost 10% more to build (10% more fees), and I can guarantee that whenever the sea level does rise 300mm, my system will work great, except since then the sea level rose just 50mm so it doesn’t look like they will have a chance to test my brilliant engineering capability for another 50-years or so, on the current trend-line.

Source: Discoverymagazone.com, 23 Aug 2011
Meanwhile the experts droned on and on in Durban…we heard:

QUOTE:
“[Starbucks] is now preparing for the possibility of a serious threat to global supplies…What we are really seeing as a company as we look 10, 20, 30 years down the road – if conditions continue as they are – is a potentially significant risk to our supply chain, which is the Arabica coffee bean.”      
~  Jim Hanna, Sustainability Director, Starbucks, on the impacts coffee farmers are seeing from a changing climate with severe hurricanes and more resistant bugs reducing crop yield.

END QUOTE:

I went into a Starbucks the other day, for the second time in my life. That’s on account of I resent having to queue up like a politically-correct American to buy a $5 cup of coffee in a low-wage economy, particularly where my bill includes 15% “service” that I know doesn’t get anywhere near the low-wagers who served me.

Personally I prefer to be able to sit down and have a low-wager practice their six words of English on me, pay $3 for the coffee, plus $1 service and tax, and slip the low-wager $1 directly, not so much as a reward for muddling up the order, as for “attitude”.

But I was meeting a yuppie and the only place yuppies can meet for anything is Starbucks, so I made an exception. He was late so I ordered a double-espresso; and after standing in a queue for about five minutes, what I got came in a paper-cup.

I said, “I’m sorry; but I want a proper cup”. That’s the whole point about a $5 espresso; it comes in a real cup. The very nice “low-wage-team-member” explained to me with a brilliant smile, “sorry but people keep stealing them and we ran out”. I said, “OK but I’m not going to steal the cup, I’ll give you a deposit if you like”.

Anyway, they gave me my money back, but then I had a problem because to sit-down in the ambiance you are supposed to buy something, and I was waiting for my meeting.

I solved that problem by asking for a complaint-form to fill in. When I got one, after about ten minutes, I noticed it said that Starbucks takes customer satisfaction very seriously; and that “customer-relations” would call or send me an e-mail. Of course they never did, even though I didn’t even put down any expletives, and I certainly didn’t implicate the low-wagers in the scenario, I ticked “excellent” for them.

My point, I think Starbucks can put climate change fairly low down on their list of urgent things that have to be fixed to make their business model work.

Here is one idea, in low-wage economies where people will pay Starbuck’s prices so they can steal the cups, it might be a good idea to do away with the “customers like to queue so as to feel more in tune with low-wagers”, and have waiter service.

That way they can at least keep an eye on the cups, and if they really want to be sure, they could have the waiters chain them to the tables when they deliver them!!

OK so “base-case” if we are all not “good” and if I keep driving my twenty-year old Land Cruiser with a straight-six, a carburetor and a 50-year design life, into the desert, and pulling all the shiny-new-fangled toys out the sand with my elastic tow-rope, the sea level will rise six-inches in fifty-years time, and we will get to see more shots of unfortunate people in places we never heard of, getting flooded out, getting cholera, and generally not living the “Starbucks’s Dream”.

Oh well, I suppose I will need to buy more pirate DVD’s so I can avoid having that thrust down my throat on Television. That’s the base case, the world is a cruel place and I will have to spend $100 more a year on DVD’s. But I think I can get over that, in any case I probably won’t be around to care.

But if you ran out of sleeping pills…well I can recommend, hot-off the press, the latest great thoughts of the climate change guru’s, if that doesn’t send you to sleep, nothing will.

What’s interesting, if you can manage to stay awake until nearly the end; is that they say nothing about “tail-risks” or black swans, and they don’t even try and do any sort of cost benefit analysis.

Work this one out:

A: There is a 66% probability that the avoidable effects of climate-change will cause a drop in world GDP of no more than 0.1% per year going forwards.

B: There is a 1% probability that will cause a drop in world GDP of more than 35% in one-go some time after 10 years and before 30 years from now.

What’s the Net Present Value of the lost cash-flow of (A) and (B), or more to the point, which is bigger?

You probably need a Black Scholes to work that one out (and the hippies didn’t even try), but back-of-the-envelope, I figure the answer to (A) is $23-trillion in today’s prices, and the answer to (B) ranges from $19-trillion to $53-trillion, based on a world GDP in 2010 of $63-trillion.

That’s the amount of money at break-even it would be worth spending now or say over ten-years, so as to reduce the risk, assuming of course that collectively spending that amount of money now could make a difference.

That’s say $1.1 trillion a year best-case over 20-Years, up to $2.5 trillion worst-case; (of course remember that expenditure would have a trickle-down).

I have three points:

1: If the dysfunctional hippies at the IPCC could get their sums in a row, they might be able to get hold of a chunk more money to spread around their fool nephews.

2: You can’t even run a decent sized war these days with $1.1 trillion, but therein lies a question, which is more important, discovering weapons of mass-destruction in Iraq or doing something proactive to “Save the World” for our grand-children?


3: USA spent or printed at least $3 trillion on the Credit Crunch to paper-over the consequences of not understanding how black-swans can sneak up and nip you in the posterior, the European Union is about to spend that sort of money for the same thing, perhaps that money might have been better spent, elsewhere?

CONCLUSION:

Perhaps it’s time to take the hippies a little bit more seriously?

Perhaps also, the next time someone designs a port, one of the parameters given to the engineers to play with might be the question, “So how will the port work if the sea level suddenly goes up by 10-meters over five-years?

I know that sounds stupid, but if the engineers who designed Japan's Fukushima power-plant had imagined that the sea-wall designed to deal with a tidal wave, stood a 1% chance of being breached once in 100-Years.

And based on that, they had located the diesel generators that were necessary to power the pumps to cool the reactors after the earthquake sensors closed the plant down (so there was no electricity)…on the roof, instead of on the ground so they were flooded when the water came over the top of the wall, then the reactor wouldn’t have blown up.

That might have added $25 million to the CAPEX…and the cost-benefit? Well they are still working out how much that black-swan cost, but numbers in the range $70 billion to $250 billion are being floated, that’s an ROI in retrospect of 10,000 to One.

On top of that, there is the cost of the needless paranoia founded on the premise that it’s impossible to design against a black-swan, so it’s better just to do nothing and pray.

About the Author - Andrew Butter is Managing Partner of ABMC, an investment advisory firm based in Dubai that he set up in 1999, and has been involved advising on large scale real estate investments, primarily in Dubai.  (EconMatters author archive here)

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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