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Resources Magazine: A Financial Approach to Environmental Risk

12-23 - RM financialWhen we talk about risk in the financial world, we are typically referring to an asset or portfolio whose price may decrease down the road. Even though risk implies a level of uncertainty, we are able to model and measure the risks associated with these assets. One of the typical ways we do this is to assess their volatility; if their prices change often, we would argue that you take on a large risk by holding them.

When volatility is especially low, it is very likely to rise again. But before the financial crisis, the risk management tools that we generally used did not offer an easy way to measure this potential and warn people in the financial sector that these risks could change.

Since then, we have built volatility models that allow us to project how fast risks can change, using historical data to simulate a number of future sample paths for long-run risks. These tools now allow us to look back on the period of time before the financial crisis to understand why everything went wrong when it seemed to be going well. In fact, just before the crisis began, only short-term volatility was low; in the long run it was high, significantly changing the situation’s perceived long-run risks.

Risks considered “long-term” are sufficiently far in the future that what we see today only has a tiny bearing on what the long-run risk really is and include events such as economic recessions, inflation, terrorism, war, and even climate change.

Climate Change as a Long-Term Risk

So why do we think of climate change in the long-run risk category? The scientific evidence is clear that the climate is changing. However, we are not sure what the economic costs associated with this change will be or what the economic benefits would be of doing something about it. The topic of climate change includes large uncertainties that we have to address as aspects of long-run risk, but the financial community is in the business of making decisions under uncertainty. Knowing this, how should this community approach climate uncertainties?

A good initial approach is to assess the potential financial impacts of climate change. We assume that the global economy will be able to produce fewer goods and services as climate change progresses than it would without climate change. We also assume that the government will have to take a number of actions, such as building dikes or moving power plants, and that funding these actions will require raising taxes and will increase the cost of doing business for companies. Costs from doing so may be significant, but they are far in the future and uncertain as of now. Revealing more information on these costs requires projecting and comparing a variety of long-run risk scenarios for the stocks or assets in question.

If you think about the whole of the market as being one large, risky asset that faces a long-run climate change risk, then we would expect today’s stock market to drop if future climate risks were seen as more severe. Conversely, we could expect today’s stock market to go up if future climate risks were thought to be less severe. Assuming these hold true, we wouldn’t have to wait 50 years or so to find out whether we’ve had a positive impact on the environment and would instead see the stock market respond today. If we are effective at responding to climate change, the stock market should reward us today for taking these steps to reduce long-term risk in the future.

Read the rest of this article.

RFF ON THE ISSUES: Lima climate action; Oil’s foreign policy impacts

Note: RFF on the Issues will be on hiatus until the new year.

Lima Climate Action

The United Nations Climate Change Conference in Lima ended with the creation of the “Lima Call for Climate Action,” which was designed to appease poor nations concerned about shouldering disproportionate economic burdens, as well as rich nations who want “fast-growing economies to rein in fast-rising emissions.”

In a recent Marketplace interview, RFF’s Ray Kopp discussed how climate agreements involving the responsibilities of rich and poor countries have traditionally been framed. Kopp comments: “The way the paradigm has been laid out for the last 20 years, developing countries—China included—really don’t have to take actions or make commitments. Only the developed world needs to do that.”

Oil’s Foreign Policy Impacts

Low oil prices have the potential to impact US foreign policy goals involving countries that depend on the production and export of crude oil. Losing large amounts of oil-based income could “prod Russia into abiding by a ceasefire in Ukraine [or] make Iran more pliable in talks over its nuclear program,” but may also “hurt some governments the US wants to protect,” such as Nigeria.

RFF’s Stephen Brown recently discussed the effects of plummeting oil prices on US diplomacy and energy security interests on RFF’s blog. Brown writes that while output is likely to drop in “politically stable countries” with higher production costs, cheap oil will cause income losses in countries such as Russia, Iran, and Venezuela that may “weaken their ability to oppose US interests.”

This Week in the RFF Library Blog

Each week, we review the papers, studies, reports, and briefings posted at the “indispensable” RFF Library Blog, curated by RFF Librarian Chris Clotworthy.


Disclosing the Facts 2014 : Transparency and Risk in Hydraulic Fracturing Operations
[Bloomberg]  While a handful of shale drillers including BHP Billiton Ltd. (BHP) are providing better information to investors on the risks posed by fracking, industry wide efforts still fall short. – via As You Sow | Boston Common Asset Management | Green Century Capital Management | Investor Environmental Health Network (IEHN)

The Economic and Budgetary Effects of Producing Oil and Natural Gas From Shale
Recent advances in combining two drilling techniques, hydraulic fracturing and horizontal drilling, have allowed access to large deposits of shale resources—that is, crude oil and natural gas trapped in shale and certain other dense rock formations. As a result, the cost of that “tight oil” and “shale gas” has become competitive with the cost of oil and gas extracted from other sources. Virtually nonexistent a decade ago, the development of shale resources has boomed in the United States, producing about 3.5 million barrels of tight oil per day and about 9.5 trillion cubic feet (Tcf) of shale gas per year. Those amounts equal about 30 percent of U.S. production of liquid fuels (which include crude oil, biofuels, and natural gas liquids) and 40 percent of U.S. production of natural gas. Shale development has also affected the federal budget, chiefly by increasing tax revenues. – via Congressional Budget Office

New York State: A Public Health Review of High Volume Hydraulic Fracturing for Shale Gas Development
[New York Times] … the long-awaited health study finally materialized, its findings made public during a year-end cabinet meeting convened by the governor in Albany. – via New York State Dept. of Health

US Dept. of Energy Responds to Nature article, “The Fracking Fallacy”
EIA has responded to a December 4, 2014 Nature article on projections of shale gas production made by EIA and by the Bureau of Economic Geology of the University of Texas at Austin (BEG/UT) with a letter to the editors of Nature. – via US doe Energy Information Administration

Proof Positive: The Mechanics and Impacts of British Columbia’s Carbon Tax
In 2008, British Columbia announced a bold new climate policy: North America’s first revenue-neutral tax on carbon pollution. Today, it is the toast of the world… – via Clean Energy Canada

Treatment of New Natural Gas under the Clean Power Plan

This is the tenth in a series of questions that highlights RFF’s Expert Forum on EPA’s Clean Power Plan. Readers are invited to submit their own comments to the questions and/or the responses using the “Leave a Comment” box below. See all of the questions to date here.

RFF asks the experts: Should EPA modify how it treats new natural gas plants in the Clean Power Plan? And, if so, how?

Building new natural gas plants to replace existing coal plants can be a cost-effective way to achieve emissions reductions. However, EPA’s Clean Power Plan is designed to regulate carbon emissions from existing power plants, so the potential for emissions reductions from new natural gas plants (natural gas combined cycle units) are not counted in the plan’s emissions targets. Some believe that including these plants as compliance options for states provides more flexibility. Others argue that making such investments are a short-term and imperfect fix, and that achieving even larger emissions reductions in the future will require even cleaner technologies. Should EPA modify the way it treats new natural gas plants in the Clean Power Plan? And, if so, how?

 

anthony-paul“Considering that power plants are long-lived investments, the construction of new plants today to meet the moderate goals of the current EPA proposal may be regrettable in later years if goals for emissions reductions tighten.” See full response.

—Anthony Paul, Center Fellow, Resources for the Future

 

 

john-larsen“It is important to remember that considering new [natural gas plants] as part of a ‘best system of emission reduction’ would change the stringency of emissions rate goals for some states, but it would not require any state to build new [natural gas plants].” See full response.

—John Larsen, Senior Analyst, Rhodium Group LLC

 

 

kate-deangelis“EPA should modify the Clean Power Plan so that it accounts for the emissions impacts of new natural gas combined cycle generators. Not appropriately accounting for emissions from new natural gas plants would encourage utilities to increase their dependence on natural gas, resulting in more fracking and more pollution.” See full response.

—Kate DeAngelis, Climate and Energy Campaigner, Friends of the Earth

The Future of the Endangered Species Act: Challenges, Opportunities, and Partnerships

Newly hatched bog turtle (photo: USFWSnortheast / flickr)

Newly hatched bog turtle (photo: Rosie Waluna / USFWS / flickr)

Over the last year, RFF began hosting a series of meetings between the US Fish and Wildlife Service (FWS), NGOs, and the business community to discuss future species listing and recovery decisions under the Endangered Species Act (ESA). One goal is to take stock of the ESA’s many strengths and successes over the 40 years since its passage. The act has drawn significant attention to dwindling and endangered species—less than one percent of the 2,000 species listed as endangered have gone extinct—while influencing many land management decisions that affect threatened populations.

However, the primary focus of these dialogues is on challenges facing ESA implementation in coming years. The ESA’s impact on decisions and policy has by no means peaked. In fact, we are about to enter a crucial phase of the act’s implementation—if measured only by the sheer volume of species around which determinations must soon be made. Under the 2011 multi-district litigation settlement (MDLS), FWS agreed that by the end of fiscal year 2016 it would make final listing determinations for 251 species—and achieve critical habitat designations for those proposals to the extent practicable. Beyond 2016, FWS will face hundreds of additional listing and recovery determinations. In fact, more than 600 post-2016 listing determinations are already identified. Read More

New York State Fracking Ban: Gov. Cuomo Follows “Precautionary Principle”

New York State’s Governor Cuomo today issued a ruling, backed by a long awaited report on the public health implications of “high volume hydraulic fracturing for shale gas development,” to ban the practice in New York State. The report is as important for what it does not find as what it does. It does not find a public health smoking gun. Indeed, the primary conclusion is that there is great uncertainty about what the public health effects are. Put in this light, Governor Cuomo made a decision, not unlike the French or other EU countries, to abide by the precautionary principle. That is, he is willing for the people of New York to forgo the benefits of shale gas development to avoid the highly uncertain risks posed by this development. The implication is that if and when the uncertainty about public health is reduced, another determination could be made about whether the benefits of development are worth the health (and environmental) damages. This is a perfectly legitimate point of view, although one not shared by many other governors in the United States.

Falling Oil Prices and US Economic Activity

Figure 1. Lower Oil Prices Will Boost Economic Activity in 42 States

Figure 1. Lower Oil Prices Will Boost Economic Activity in 42 States

Weak demand and abundant supply are behind the recent trend in oil prices, which have fallen by more than $50 per barrel since June. This event is not unprecedented—in fact, the conditions associated with the 2014 crude price drop are very similar to those surrounding a similar drop during 1985 and 1986. In both cases, oil conservation caused prices to decrease while dramatic production gains—then in the North Sea, now in US shale fields—pushed supply much higher than originally anticipated. As a result, the world oil market has reached a new equilibrium that follows a much lower crude price trajectory.

These lower prices will have a range of positive and negative effects that are likely to be unevenly distributed across the United States. I’ve detailed these in a new RFF issue brief. Here’s a quick guide to the economic impacts we should expect in the coming months: Read More

Resources Magazine: Developing Policies to Combat Invasive Species

Global trade—and now global warming—are making the problem of invasive species ever more challenging. From surveillance to cooperative management, Rebecca Epanchin-Niell explores options to control these damaging invaders.

The original cherry trees given to DC were infested with roundworms and other harmful insects. (source: casajump / flickr)

In 1909, Tokyo Mayor Yukio Ozaki presented the US government with 2,000 young cherry trees to be planted around Washington, DC’s tidal basin. The gift was part of a beautification effort for the National Mall.

There was one problem. When the trees arrived in Washington in early 1910, inspectors discovered they were infested with damaging roundworms and insects. The trees would have to be destroyed. US Secretary of State Philander Knox informed Japanese Ambassador Yasuya Uchida of the bad news:

The United States has suffered immense damage to its trees and its agriculture generally by various injurious insects not indigenous but introduced from foreign countries, and . . . the introduction of any new kind might result in the future in the enormous detriment to fruit growers and agriculturists of the country. From this point of view, the Department of Agriculture seems to have no choice but the painful duty of ordering the destruction of the trees.

Skillful diplomacy smoothed over any potential hurt feelings, and a new shipment of pest-free cherry trees arrived in 1912, the same year that Congress passed the landmark Plant Quarantine Act, among the first federal legislation dealing with importation of exotic species.

More than 100 years later, exotic pests remain very costly to the American economy, imposing billions of dollars in damages on crops and ecosystems. Invasive species are now a staple of news reports:

  • The Burmese python, likely introduced as a pet and now taking up residence in the Everglades, dines on everything from small mammals to endangered birds and even alligators.
  • The Asian tiger mosquito—thought to have arrived in the Port of Houston in 1985 in a shipment of used tires—is now a backyard menace in 26 contiguous states and Hawaii.
  • The zebra mussel, most likely brought over from Russian freshwater lakes in ballast water, is now driving native mussel species to near extinction and clogging water intake pipes at electric utilities from the Great Lakes to the Mississippi basin.
  • The emerald ash borer, probably introduced to the United States in the 1990s in wood packaging material, is responsible for the loss of more than 100 million ash trees since its first detection in 2002, with devastating economic and ecological impacts.

How Invasives Arrive

Invasive species are yet another manifestation of human impacts on the global environment, as human activity is far and away the main driver of species spreading to new areas. Many invasive species have even been introduced intentionally by individuals unaware of the potential negative consequences. To take a notorious example, the European starling arrived in 1890 as part of Eugene Schieffelin’s effort to bring every bird mentioned in Shakespeare’s plays to America. Many other invasive plants and animals were initially introduced as part of the horticultural or pet trade and subsequently became established in the wild.

Another important way that new invasive species arrive is by hitchhiking on other shipments, as in the case of the pests that accompanied the first gift of cherry trees from Japan. The increase in global trade and travel has exacerbated this phenomenon, with pests arriving on agricultural products, in packing material, in ballast water, and in passenger baggage.

Trade in live plants is a particularly important pathway, as it not only directly introduces plant species that have the potential to become invasive, but more importantly, it also is the most frequent medium for introduction of non-native pests of agricultural and natural resources worldwide. Of invasive forest insects and pathogens taking root in the United States in the last 150 years or so, an estimated 70 percent are thought to have arrived on imported live plants.

But not all alien species qualify as invasive. At a minimum, the species must be able to take hold and flourish in its new surroundings. Most introduced species are not able to do so, but a small percentage can, benefiting from the lack of natural controls like predators, competition, and climate fluctuations that would otherwise keep their populations in check. From a policy perspective, the species must also be harmful to be counted as invasive. The US government’s official definition is an alien species “whose introduction causes or is likely to cause economic or environmental harm or harm to human health.”

And although not all introduced species are harmful—in fact, of the food crops grown in the United States today, only a handful are actually native—enough are damaging to create serious risks for many parts of the economy. For example, the emerald ash borer alone is estimated to cause $850 million in local government control expenditures annually, as communities treat or remove urban ash trees devastated by this pest.

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Fracking in Focus: A Look at Voluntary Environmental Information Disclosure and Firm Size

CoverThe potential environmental risks posed by fracturing fluids—usually some mixture of chemicals and water—make hydraulic fracturing a highly controversial industrial process. These risks have prompted many stakeholders to request chemical disclosure reports on the fluids used by well operators. The oil and gas industry has responded by creating a fracturing chemical registry website—www.FracFocus.org—that allows operators to post information online about the location of each well and the chemicals used in its production. (Operators can also disclose their chemical usage to state agencies, but this information can be hard for the public to access because it is not available online.)

In the last few years, a number of high-production states have passed fracturing disclosure regulations that require operators to convey well and fluid information to one, both, or either of FracFocus and a state agency. Before they were passed, disclosure was voluntary in all situations; after their adoption, it became voluntary only in some cases. The voluntary disclosure of such information is considered to be a type of corporate social responsibility (CSR) activity, in which a company goes beyond minimum legal requirements. Read More

RFF on the Issues: Water management projects; Debris brings invasive species

Water Management Projects

Los Angeles—long known for its high water consumption—has recently become a “leader in sustainable water management” thanks to a host of new conservation, collection, and reuse policies. The city now uses “less water than it did in 1970 while its population has grown by more than a third.”

In a new blog post, RFF’s Yusuke Kuwayama comments on a recent US Geological Survey report indicating that water withdrawals nationwide have dropped by 13 percent between 2005 and 2010. He writes: “Instead of taking these latest withdrawal estimates as an indication to ease up on water management activities, we should interpret them as evidence that our policies are starting to work, and that further analysis is needed to ensure that these policies to continue to protect out water sources in a cost-effective manner.”

Debris Brings Invasive Species

More debris from the 2011 Japanese earthquake and tsunami is expected to wash ashore in the Pacific Northwest this winter, bringing a number of potentially invasive species into the area. Researchers are concerned that organisms native to Asia traveling with this debris will “introduce new diseases and compete with, displace, or otherwise affect” species along the coasts of Washington and Oregon.

In a recent Resources article, Rebecca Epanchin-Niell notes that the key to reducing damages from invasive species is to detect them early, when it is “less costly to contain or eradicate” establishing populations. Because “even the best-designed inspection strategy” will not offer a region full protection against bioinvaders, Epanchin-Niell writes that policymakers should focus on using surveillance strategies as cost-effective policy tools.