July 12, 2018

Time to Wake Up: Crash Conditions

Mr. President, I spoke before the Fourth of July recess about two financial risks that are coming our way thanks to not getting anything done on climate change.

One, of course, is the risk to coastal properties–not something the Presiding Officer has to worry too much about given his home State but something that Rhode Island, the Ocean State, has to care a lot about and that the distinguished Senator from Florida and his constituents have to care a lot about.

There is a point where rising sea levels intrude on the saleability, the mortgageability, and the insurability of houses. None other than Freddie Mac, the huge Federal housing corporation, is predicting that there will be a coastal property meltdown.

The other risk is that of a carbon bubble. There is a lot of talk in the economic literature about a carbon bubble. One recent financial study reports that “the potential effects of a carbon bubble on financial stability have been recently discussed in the academic literature and are increasingly on the agenda of [bank] regulators and supervisors.” Indeed, in an official statement, the Bank of England has warned that “investments in fossil fuels and related technologies . . . may take a huge hit.” That huge hit is the other side of a carbon bubble: It pops, and you have a crash. So let’s look at the prospects for not just a carbon bubble but a carbon crash.

There are several elements in the run-up to a crash. Some of these we witnessed in the crash of the housing bubble back in 2008. When these conditions exist, we should take warning.

One condition is whether you can trust the players. In the housing crash, the rating agencies were in bed with the banks, and you couldn’t trust their risk evaluations. The whole thing was cooked. The big fees the rating agencies were taking also took their eye off the ball, and they gave wildly erroneous ratings to high-risk investments. So at the heart of the 2018 housing crash was a failure of trustworthiness.

Can we trust the fossil fuel industry any better than those rating agencies? There is no reason to think so, and there is plenty of reason to think not. This is an industry that has been lying about fossil fuel’s effect on our climate for decades, and once you get used to lying about one thing, it is hard to contain the spread of the rot. Exxon even once gave its CEO the infamous, phony Oregon Petition, which urged the United States to reject the Kyoto Protocol, to cite to shareholders at an annual meeting.

I have spoken before about what I consider to be the untrustworthiness of Exxon’s response to the BlackRock shareholder resolution, which required Exxon to report the predicted effect of climate policies on Exxon’s business model. As fossil fuels are priced out of the market by renewable energy and as nations enact carbon emissions restrictions, fossil fuel reserves now claimed as assets by energy companies may become undevelopable stranded assets.

In a nutshell, Exxon seems to have wildly–indeed, so wildly, you can only conclude deliberately–overestimated the adoption of carbon capture utilization and storage, wildly underestimated the adoption of electric vehicles, and wildly underestimated renewable energy growth, all to reach its rosy conclusions that its assets were more or less secure.

On the subject of trustworthiness, right now big oil companies are still being untrustworthy, telling the world they want a price on carbon, while at the same time telling their political fixers in Congress to kill any such thing. Who knows how much they push around their analysts and others who are curious about a carbon bubble. What we know is that trusting this industry is asking a lot. That is condition one for a bubble in a crash–untrustworthy actors.

Condition two is market failure. Markets usually correct and have a smoothing effect. If there is market failure, markets can go off course until the correction comes, and then the correction is so immediate and so big that it amounts to a crash. There is market failure in fossil fuel that props up this bubble. Indeed, there are several. The biggest is that the fossil fuel industry rides on what the IMF calculates is a global multitrillion-dollar annual subsidy: $700 billion in subsidy every year in the United States alone, says the International Monetary Fund. That subsidy massively warps the operation of the market.

There is also what appears to be a methodological issue. The oil industry is ordinarily measured financially by net asset value analysis. As one paper noted, this is an “industry valuation methodology [that] assumes full extraction of fossil fuel reserves.” A methodology that assumes full extraction of fossil fuel reserves becomes a problem when the question is whether extraction of those reserves is even possible.

There is also what I would call a “massiveness factor” at work here. Lehman Brothers and Bear Stearns were so massive that it was hard to imagine them vanishing, but they did. The market value of fossil fuel reserves that can’t be burned is around $20 trillion, according to the World Bank. That is such a big wipeout that it is hard to comprehend, let alone anticipate. People wait until tomorrow. Then, the tomorrows pile up into a bubble, and then the crash comes when the first person panics and everybody runs.

One other market failure is actually how the crooked political pressure of this industry is causing us not to focus on the 2-degree Celsius ceiling that scientists warn us about for global warming, or, actually, safer yet is the 1.5-degree Celsius ceiling, which burning existing reserves will blow us through. We cannot have both a safe planet and full extraction, and the fossil fuel industry is choosing extraction.

That political castle of climate denial will fall sooner or later. It is false. Not only is condition one met–untrustworthy players–but condition two is met: There is a massive, multiple market failure in fossil fuel awaiting correction, which brings us to condition three: The energy market is undermining fossil fuels as a technology.

We are reaching a tipping point. Here is Lazard’s cost curve for onshore wind energy. It shows, over 8 years, a 67-percent decrease in cost. This line shows the cost of wind energy steadily declining from 2009 until 2017.

At the same time these wind costs were dramatically declining, utility-scale solar costs and rooftop solar costs also declined dramatically. This line represents rooftop solar costs. This line below it represents utility-scale solar costs. Again, there was a percentage decrease of 86 percent.

New solar and wind energy projects are already becoming more economical than existing coal plants, as we just saw in Colorado. New solar and wind projects now compete on price with new natural gas plants, as a recent auction in Arizona showed.

The cost trajectory for renewables continues steeply downward. When you compare U.S. wind and solar to other energy sources, you see the trend is clear, and here is the result. On cost, the lowest cost providers are onshore wind and utility-scale solar. More expensive than them is natural gas. More expensive is coal. More expensive still is nuclear. That is not counting the subsidy. That is apparent price.

This same trend is also happening globally. This graphic is prepared by the World Economic Forum, and it shows the same thing for renewables. In particular, here is the rapidly declining cost of solar photovoltaic. Here is the cost of coal, and here, right now, they cross over. We are at the tipping point, where it is cheaper worldwide to develop solar and wind than it is to burn coal.

Stanford economist Tony Seba studies economic disruptions, and he likes to see these two photographs. It will be hard to see from where you are. This is Fifth Avenue in New York City in 1900. If you look at the photograph, you can see that every vehicle there is drawn by a horse. In 1900, every vehicle was drawn by a horse. If you look very closely, it appears there is one leading-edge, non-horse-drawn vehicle. The whole street is filled with horse-drawn carriages and wagons in 1900. Thirteen years later, on Fifth Avenue in New York City, every single vehicle in that street is now an automobile. In only 13 years, there was a complete transition in transportation. If you were a harness maker, this was a tough transition for you. In just 13 years, the world changed, illustrating the point that major economic disruptions can take place fast. Think land lines and cell phones, if you want a modern example.

People still ride horses, and they probably always will, but our transportation sector shifted rapidly from horse-drawn conveyance to automobiles because horse-drawn conveyance was an antiquated technology that got left behind. People still have landlines. I have one at home. We hardly ever use it. The communications industry shifted rapidly, as antiquated landline technology got left behind.

As the energy market shifts to cleaner, cheaper, more efficient renewable technologies, fossil fuels soon will not compete in the marketplace. There is our third condition: not just untrustworthy players, not just market distortion, but also a technological tipping point making the fossil fuel technology obsolete.

There is a fourth condition. This fourth condition basically puts an accelerator on condition three in certain sectors of the energy market. Condition four is based on the fact that the marginal cost of production of a unit of fossil fuel energy varies considerably. Some fuels are low cost and high cost to produce. Some geographical locations are low cost and high cost locations. In this variance, coal is pretty much dead already at the hands of oil and gas, purely because of cost. We can set coal aside for a moment.

In the world’s oil markets, much of this cost of production variant is masked right now by energy cartels that prop up the price of oil. Cartel behavior to prop up the price of your product makes economic sense if you can maintain monopoly pressure to prop up the price, but it also only makes sense for the cartel participants if you can anticipate that you can sell your product out into the future. You hold back your output to drive up price and to maximize your return in the hopes that in the future you will be able to keep doing the same thing and you will be able to sell your product.

If you are not sure that there will be another day to sell your product at the propped-up price, you start to get anxious about your product becoming stranded and about your product becoming valueless. At that point, it doesn’t make sense to engage in cartel behavior. What makes sense is to maximize your output and to sell as much as you can while your commodity still has value–basically, to have a fire sale.

Low-cost fossil fuel energy producers would be rational to drop their prices and maximize their market-share, fire-sale pricing while their fossil fuel still has value. Get the dammed stuff out the door while you still can. That behavior–dropping the cost, pricing at your marginal cost of production, and selling as much of your product as you can–will fend off the inevitable for low-cost producers for a while. However, for those producers that can’t match that fire-sale price, the downward trajectory of their crash steepens catastrophically. As soon as you can’t produce not at the cartel price but at the lowered fire-sale price–as soon as you cannot meet that price–you are out of business. There still is a fossil fuel market. You are just not in it. The bad news for the United States is that this is where much of our market is. Economists looking at this carbon bubble mess warn that high-cost regions like the United States could “lose almost their entire oil and gas industry.” Let me quote that again: “lose almost their entire oil and gas industry.”

To recap about a fossil fuel “carbon bubble,” the players aren’t trustworthy; the fossil fuel markets aren’t efficient in the economic sense; fossil fuels as a technology are now tipping into being obsolete, priced out by renewables; and our U.S. industry is particularly vulnerable to an accelerated market meltdown when the tide shifts.

Those four conditions don’t make a great scenario. That is a warning we need to start considering. What should we do?

Everyone seems to agree on two safety measures. First, there is one sensible hedge: Don’t invest all in fossil fuel. Invest more in renewables. Be on the winning side of the shift. Start making carburetors, not just a mule harness. There is also one important, sensible economic strategy; that is, to manage the transition.

As one paper on this subject concluded, “The issue of concern is the lack of any transitional strategy. . . . Inadequate, conflicting or slow responses to climate change in investment and finance can entail risks that could be avoided under a more orderly transition.”

You could equate it to jumping out of an airplane. You are going to end up on the ground anyway. Wouldn’t you like a parachute to make it a gentler and more survivable voyage? What is the parachute but a transition plan for managing this shift? The best one is a price on carbon.

This takes us back to the discreditable conduct of the fossil fuel industry, which, far from leading through this transition, far from trying to build itself a parachute, is busily still trying to deny that there is any such transition, including, in my view, their falsely reporting to shareholders that this is all going to be OK, and we are going to be able to extract and sell all of our reserves. This is an industry that is still fighting like a wounded bear to prevent anyone from organizing the orderly transition they need.

At some point, there has to be a grownup in the room. The fossil fuel industry has shown no capacity for that role, which makes it up to us in Congress to help America prepare for both the predicted crash in coastal property values, as sea level begins to enter the mortgage and insurance horizon for those properties, and the predicted carbon bubble we see coming and that economists write about coming that we can manage our way through if we are responsible. In that regard, it is time for us to wake up.

I yield the floor.

I suggest the absence of a quorum.