Rising at the Interest Rate?

With oil back at $70, I got curious how Hotelling is holding up. The observation that resource prices ought to rise at the interest rate is looking almost plausible now, if you squint, whereas it looked rather foolish for most of the 80s and 90s. Of course, the actual production trajectory has nothing to do with Hotelling’s simple model, which produces a monotonic decline. The basic problem with Hotelling, as I see it, is that there’s a difference between equilibrium and expectations subject to uncertainty. Moreover the extraction trajectory is largely controlled by the rate at which governments lease or otherwise exploit resources, and governments have more than the usual dose of bounded rationality. (I got interested in this because I’ve been investigating Montana’s management of mineral rights on its school trust lands. So far, the state’s exercise of its fiduciary responsibility looks suspiciously like a corporate welfare program. More on that another time.)

Oil vs Interest Rates

The figure compares the nominal oil price trajectory to actual risk-free rates (3month T-bills and the federal funds rate), as well as three constant rates for good measure. At those rates, one would have to conclude that a large risk premium must apply to oil production, or that there’s been an awful lot of uneconomic production over the years (for example, everything from about 1986 to 2006), or that current prices are just a blip and will continue to revert to some more moderate long-term level.

Climate, the Bailout, and the Blame Game

I’ve been watching a variety of explanations of the financial crisis. As a wise friend noticed, the only thing in short supply is acceptance of responsibility. I’ve seen theories that place the seminal event as far back as the Carter administration. Does that make sense, causally?

In a formal sense, it might in some cases. I could have inhaled a carcinogen a decade ago that only leads to cancer a decade from now, without any outside triggers. But I think that sort of system is a rarity. As a practical matter, we have to look elsewhere.

Socioeconomic systems are at a constant slow boil, with many potential threats existing below the threshold of imminent danger at any given time. Occasionally, one grows exponentially and emerges as a real catastrophe. It seems like a surprise, because of the hockey stick behavior of growth (the French riddle of the lily pond again). However, most apparent low-level threats never emerge from the noise. They don’t have enough gain to grow fast, or they get shut down by some unsuspected negative feedback.

Continue reading “Climate, the Bailout, and the Blame Game”

Dimensions of The Deal

In the Tällberg event we talked a lot about the deal we need, without really defining what was meant by that. I think it has at least four dimensions:


What science drives the goal? Is it 350ppm? 450ppm? 550ppm? 2C?


What regions or sectors will move first, and what transfers will the rich or the winners use to induce the poor or the losers to play along? Do transfers consist of money, intellectual property, or both?


What form will commitments take, who will make them, and how will they be implemented? Will the mechanism favor taxes or trading, for example? Will standards be expressed as intensities or absolute emissions or … ? How will goals and mechanisms adapt as we learn about uncertainties?


We don’t have a deal now because we don’t have the coalition needed to make it happen. Some combination of the public, politicians, media, religion, education, etc. needs to come together to create critical mass behind a policy. We have fragments (the EU, California) but not a whole. I rather doubt that there is a quick, transformative solution (unless catastrophe drives us to one, which I’d rather not contemplate).

I say “critical mass” deliberately, because what we’re all implicitly searching for is a reinforcing feedback that will grow policy out of its current dysfunctional state. The question is, what is that loop? My guess is that it involves starting gradually. Don’t shoot for the moon and fail. Instead, take a little medicine at first. Impose a modest carbon tax. Observe that the economy doesn’t collapse, and efficiency is cheap or even profitable. Greentech gets a little more profitable, and the more numerous low-carbon voters grow to enjoy their tax rebates. Enlisting their support allows the tax to be ratcheted up further, and soon you’re rolling toward real emissions controls. But is the gain on that loop high enough to yield emissions reductions in time to avoid catastrophe?

Hansen on The Deal

Jim Hansen kicked off the Tällberg panel with a succinct summary of the argument for a 350ppm target in Hansen et al. (a short version is here). As I heard it,

  • The dangerous level of GHGs in the atmosphere is lower than we thought.
  • 3C climate sensitivity from fast feedbacks is confirmed; the risk is slow feedbacks, which are not as slow as we thought.
  • There is enough warming in pipeline to lose arctic ice, glaciers, reefs.
  • Good news: we need to go back to the stable Holocene climate.
  • The problem is solvable because conventional oil and gas are limited; we just need the will to not burn coal, oil shale, etc., except with CCS.
  • Among other things, that requires a price on carbon; for which a tax is the preferred mechanism.
  • The only loser is the fossil fuel industry; we simply need to bring them to heel.

Hansen was a little impatient with our bit of the forum, and argued that our focus on regions (and the challenges in reaching a regional accord) was too pessimistic. Instead, a focus on fuels (e.g., phasing out coal) provides clarity of purpose.

My counterargument, which I only partially articulated during the session, for fear of driving the conversation off on a tangent, is as follows:

As a technical solution, phasing out coal and letting peak oil run its course probably works. However, phasing out coal by 2030 implies a time constant of seven years or a rate of decline in coal utilization of about 10%/year (by the 3-tau rule of thumb). Coal-fired power plants have a long lifetime, so the natural rate of decline, assuming no new coal investment, is more like 2.5% or 3%/year. Phasing out coal at 10% per year implies not only halting construction, but also abandoning many plants before their natural economic lifetime is up. Age structure complicates things a bit, perhaps making it easier in the US (where plants are disproportionately old) and harder in China (where they’re new). Closing plants ahead of schedule is going to make the fossil fuel interests that Hansen proposes to control rather vocally upset. Also, eliminating coal emissions that fast requires some combination of rapid deployment of efficiency, noncarbon energy sources, and CCS above natural rates of capital turnover, and lifestyle change to pick up the slack. That in itself is a significant challenge.

That would be doable for a coalition with enough political power to either overpower or buy off the owners of stranded assets. But that coalition doesn’t now exist, and therein lies the reason that this is a political problem more than a technical one.

Random Reflections on The Deal

The following are some stream-of-consciousness insights that struck me from other presentations and audience comments during the Tällberg event. Apologies to Bo Ekman, Bob Corell, Christine Loh, Johan Rockström, and other unattributed sources of these thoughts – my notes just aren’t that good.

There’s much tearing of hair and gnashing of teeth in attempts to interpret the UNFCC objective, “stabilization of greenhouse gas concentrations in the atmosphere at a level that would prevent dangerous anthropogenic interference with the climate system.” But the convention actually provides a useful definition in the very next sentence, “Such a level should be achieved within a time-frame sufficient to allow ecosystems to adapt naturally to climate change, to ensure that food production is not threatened and to enable economic development to proceed in a sustainable manner.” That’s already a fairly stringent and specific requirement.

    The mood of the Club of Rome, and of statements about the state of ecological and social systems in general, is gloomy, i.e. that issues raised 40 years ago regrettably are now more acute and immediate.

      Climate is not a future problem, it’s happening now.
      It’s not a gradual process; it could happen drastically.
      It’s not globally uniform; regional variations are large.
      It’s not an environmental problem; it’s connected to an array of issues in many domains (oil security, ecosystems, water, refugees, the real and money economies). Developments in the money economy rely on the underlying real economy, which in turn relies on resources, yet finance ministers routinely trump environmental decisions and few environmental agreements are honored.

        Sovereignty is one of the notions that stands in the way of agreements; such fundamental principles need to be rethought. The philosophical problem leads to practical problems. For example, enthusiasm for cap & trade, at least in some quarters, stems from the idea that it could be used as a mechanism for transfers from rich to poor nations, for example via allocation of emissions permits on a per capita basis. An ideal system would have to operate person to person though. If governments receive allowances, the system risks becoming a mechanism for the elites of the poor world to fleece the rich world, with limited benefit to the poor.

          As soon as one accepts the framing of climate change as, how to sustain GDP growth, or as a cost-benefit problem, half the battle is lost. The ‘economy as means’ is confused with ‘economy as end’. The solution needs to connect to well being. This is difficult, because of role confusion – so many of the interests involved in creating a solution are also dependent on the creation of consumer demand. Seen in that light, there might be a silver lining to the financial crisis. It is distracting, but it might also be the storm of creative destruction that provides fertile ground for growth of new interpretations of well being and new economic goals.

            The world of climate negotiation is closed. Negotiations are driven by diplomats who’ve been at it for years, and resist information sources and constraints representing reality. Environment ministers complain that they have no influence over the outcome. Nature needs to be brought into the room (exactly what we’re trying to do).

              Tol Talks Tax

              Stumbled upon while searching for a reference: Richard Tol Changes Tune, Talks Carbon Tax. From what I’ve read, Tol is too much of a nonconformist to club with the professional skeptics, and has probably always preferred a Hotelling-style carbon price trajectory, so I’m not convinced that this is really a change, but it’s intriguing.

              Questioning Imbalance

              Nature has a review, by economist Dieter Helm, of William Nordhaus’ new book, A Question of Balance. I don’t have the book yet, but I’ll certainly check it out. I like the conclusion of the review:

              But it may be naive to assume that substituting for environmental systems is so easy. Feedbacks in the system may be such that as climate change unfolds, the return on capital and hence the discount rate falls. Environmental damage may slow or stop economic growth; if that were the case, we would not be much better off in the future. And if we are not so well off in growth terms, Nordhaus’s slower and more measured policy approach may not be so favourable over taking rapid action now. In other words, Stern’s conclusion might be correct, but not his derivation of it ’” right answer, wrong analysis.

              This is a crucial point. Richard Tol pointed out the substitutability problem back in 1994 but it hasn’t really found its way into formalization in mainstream IAMs. The issue of slowing or stopping growth isn’t limited to climate feedback; oil and gas depletion, the ever-present possibility of conflict, and degradation of other resources also impose constraints.

              I have to take issue with one part of the review:


              Where A Question of Balance has most power is where it is most controversial. Nordhaus tackles Stern head on. Stern’s case for urgent action, which the DICE model shows would be excessively expensive in the short term, rests upon his radical assumption that the time discount rate should be close to zero. This means that we should value people’s consumption equally regardless of whether they live now or in the future. Nordhaus has little time for this moral philosophy: he takes a much more positivistic position, grounded in market evidence and what people actually do, as reflected in market interest rates. The difference between Nordhaus’s optimal climate change policy and Stern’s policy based on a zero discount rate translates into a tenfold difference in the price of carbon. Stern’s discounting approach, Nordhaus argues, gives too low a rate of return and too big a savings rate on climate-stabilizing investments compared with actual macroeconomic data. Not surprisingly, then, his verdict is damning. [emphasis added]

              The Stern discounting critique has been done to death. I recently discussed some of the issues here (in particular, see the presentation on discounting and welfare in integrated assessment modeling, based on the primer I wrote for last year’s Balaton meeting). In a nutshell, the discount rate can be decomposed into two terms: pure time preference and inequality aversion. Ramsey showed that, along an optimal growth path,

                interest rate = pure time preference + inequality aversion x growth rate

              Stern has been criticized for choosing discounting parameters that aren’t consistent with observed interest and growth rates. That’s true, but let’s not confuse the map with the territory. Stern’s choice is inconsistent with the optimal growth framework, but is the optimal growth framework consistent with reality? Clearly, market interest rates reflect what people actually do in some sense, but they do it in a rather complex institutional setting, rife with opportunities for biases and misperceptions of feedback. Do market interest rates reflect what people actually want? Unfortunately, the micro foundation of macroeconomics is too wobbly to say.

              Notice also that the equation above is underdetermined. That is, for realistic growth and interest rates, a variety of pure time preference and inequality aversion assumptions yield equality. Nordhaus, in his original DICE work, preferred 3%/yr pure time preference (no interest in the grandkids) and unit inequality aversion (doubling my income yields the same increment in happiness as doubling a poor African farmer’s income). Dasgupta prefers zero time preference on ethical grounds (as did Ramsey) and higher inequality aversion. The trouble with Nordhaus’ approach is that, unless the new book cites new research, there is no empirical basis for rates of time preference that heavily discount the future. It is difficult to create a realistic simulated context for such long term decisions, but the experimental evidence I’ve seen suggests quite the opposite, that people express some concern for even the distant future.

              Thus it’s a mistake to call Nordhaus’ approach “positivistic.” That lends undue authority to what should be recognized as an ethical choice. (Again, this is subject to the caveat that Nordhaus might have new evidence. I await the book.)

              Aviation Pontification

              Last week I presented in an INFORMS 2008 panel, Role Reversal: The Impact of Climate Change on Aviation. My slides are here (you’ll miss a model demo using a carbon cycle/climate model, but that wasn’t central). I got challenged on one assertion – that participation in regional initiatives is meaningful – on the grounds that federal preemption definitively assigns aviation regulation to the national level. That may be so, but I suspect that mental models formed through regional experimentation will still shape what happens nationally. Without early involvement, aviation could find itself getting pounded into the nearest available policy pigeonhole, regardless of fit. Avaitors joke that, “gravity never loses; the best you can hope for is a draw.” The same could perhaps be said of aviation’s chance of withstanding the inexorable consequences of GHG accumulation.

              The Deal We Ain't Got

              Today, Drew Jones and I presented a simple model as part of the Tällberg Forum’s Washington Conversation, ‘The climate deal we need.’ Our goal was to build from some simple points about the bathtub dynamics of the carbon cycle and climate to yield some insights about what’s needed. Our aspirational list of insights to get across included,

              • stabilizing emissions near current levels fails to stabilize atmospheric concentrations any time soon (because emissions now exceed uptake of carbon; stabilization continues that condition, and the residual accumulates in the atmosphere)
              • achieving stabilization of atmospheric CO2 at low levels (Hansen et al.’s 350 ppm) requires very aggressive cuts (for the same reason; if carbon cycle feedbacks from temperature kick in, negative emissions could be needed)
              • current policies are not on track to meaningful reductions (duh)
              • nevertheless, there is a path (Hansen et al.’s “where should humanity aim” paper lays out one option, and there are others)
              • starting soon is essential (the bathtub continues to fill while we delay – a costly gamble)
              • international negotiation dynamics are tricky due to diversity of interests, coupled problem spaces, and difficulty of transfers (simulations shadow this)
              • but everyone has to be on board or little happens (any one major region or sector, uncontrolled, can blow the deal by emitting above natural uptake)

              A good moment came when someone asked, “Why should we care about staying below some temperature threshold?” (I think a scenario with about 3.5C was on the screen at the time). Jim Hansen answered, “because that would be a different planet.”

              The conversation didn’t lead to specification of “the deal we need” but it explored a number of interesting facets, which I’ll relate in a few follow-on posts.

              There's always something more pressing …

              One reason long-term environmental issues like climate change are so hard to solve is that there’s always something else to do that seems more immediately pressing. War? Energy crisis? Financial meltdown? Those grab headlines, leaving the long-term problems for the slow news days:

              Google trends - climate change vs. bailout

              Google Trends

              In this case, I don’t think slow and steady wins the race. The financial sector gets a trillion dollars in one year, and climate policy gets the Copenhagen Consensus.

              Continue reading “There's always something more pressing …”