Uncertainty about Major Challenges of the 21 st Century

Transcription

1 Uncertainty about Major Challenges of the 21 st Century Yuri Yegorov, University of Vienna SKISD, 2 nd International Symposium on Sustainable Development, St.Petersburg, Russia, September 2013

2 Danger of global warming Yegorov, Uncertainty, St.Petersburg, SKISD

3 Danger from global oil scarcity (oil peak) Yegorov, Uncertainty, St.Petersburg, SKISD

4 Abstract What will come first non-acceptable global warming or extinction of oil reserves? Both processes can bring substantial costs to the mankind, but their order has important economic implications. If we decide that global warming is the major challenge for the 21 st century, we should stick to Kyoto-type agreements and to limit use of fossil fuels, replacing them by biofuels and other renewable energies. In this case the market value of resource-holding companies should drop since full exploitation of their reserves will bring global warming to nonacceptable level. Since oil reserves are finite (currently for 40 years), global oil production will reach its historical maximal level and then drops. The socio-economic consequences of it will be quite substantial, and the process of full oil substitution by alternative fuels can take several decades. If oil peak comes before substantial global warming and if oil replacement is slow, then the value of oil companies would skyrocket. Yegorov, Uncertainty, St.Petersburg, SKISD

5 Introduction The presented model is about the expected value of global future output, when both costs are taken into account. An important policy implication comes when ex ante predictions about order of both challenges will not coincide with actual realization. In this case we can observe a bubble with value of oil companies, when their value first declines and then grows up (or visa versa). This market disequilibrium drive by irrational expectations (or false information) can be exploited by speculators in financial market, and the owners of resource companies should be aware about that. V.I.Vernadskiy was a great thinker who suggested the term of noosphere as the product of interaction between human civilization and the nature. The history has confirmed the validity of most of his predictions, but we also have got some problems from global changes of such scale. This paper is also about the global phenomena that are likely to dominate the global threats for mankind in the 21 st century. Yegorov, Uncertainty, St.Petersburg, SKISD

6 Global Warming Global warming (GW) is currently considered as the major challenge of the 21 st century. However, we have quite substantial uncertainties about its dynamics, costs and possibilities to influence it. So far, the rise of global temperature during the last 50 years just by1 degree has been observed. Indeed, we observe more frequent climate extremes; but are they due to this 1 degree change? When the level of global ocean will start to rise substantially due to ice melting? When we get plus 3 or plus 5 degrees? (Most scientists in climate change agree that many unacceptable changes then). But how much fossil fuels should we burn to get there? I heard at IAEE conference (Dusseldorf, 2013, F.Holz) that catastrophic consequences for climate change will occur, if we burn 1000 Gt. This is more than oil reserves (662 Gt), but about what conventional oil and gas give jointly. It may happen that this border of 1000 is fuzzy, and be something between, let say, 500, and Also we do not know what does unacceptable change mean exactly. Yegorov, Uncertainty, St.Petersburg, SKISD

7 Yegorov, Uncertainty, St.Petersburg, SKISD

8 Concentration, Tempertaure, Damages Stern Report Yegorov, Uncertainty, St.Petersburg, SKISD

9 Scarcity of Fossil Fuels The global scarcity of fossil fuels (FS) might be another challenge to the mankind. (Here I do not focus on water and other finite resources.) While the known reserves of all fossil fuels are more that for 200 years of use (at current consumption), known reserves of conventional oil are only for 40 years. But what will happen if Saudi Arabia or Russia overestimate its reserves? There is oil peak theory saying that oil production will peak globally, i.e., supply cannot be increased even if demand will grow. Will this peak be at 90, 100 or 120 bbrl/d, nobody knows. Also it is not clear if it will happen in 10, 20 or 30 years. (M. D. Salameh says that conventional oil has already peaked in 2006, and now increase comes at the expense of tar sand, produced by Canada at high economic and environmental costs.) There are also studies about potential severe consequences of oil peak as a global shock to economy with very high costs, if it comes unexpectedly. We got rid of oil in electricity production, but we have no other fuel yet for air transport today, and we need few decades to make transition. Yegorov, Uncertainty, St.Petersburg, SKISD

10 Different scenarios for world oil production. Source: Yegorov, Uncertainty, St.Petersburg, SKISD

11 US economic growth depends on used energy. Oil peak will lead to deep recession. Yegorov, Uncertainty, St.Petersburg, SKISD

12 Paper Goals The first objective is to show very important policy implications of the order and timing of those challenges (global warming and oil peak). The problem is that modern science cannot exactly estimate neither the level nor the social cost of global warming; it can do only probabilistic estimate. On the other hand, we do not know the volume of nondiscovered fossil fuels. Thus, it is possible to discuss some probabilistic (or even fuzzy) values. Another goal of this paper is to compare both dangers and to evaluate their influence on commodity markets, in particular, on price dynamics for fossil fuels. A highly stylized model is developed. It might be far from reality. It is also not clear whether the economic damage from both will be temporal in time or not. The role of discount rate is also very important for economic decisions. Yegorov, Uncertainty, St.Petersburg, SKISD

13 The Model If we continue without significant efforts to reduce CO2 emissions, global temperature will increase over time, and irreversible melting of ice will start, raising the level of ocean. Hazard cost will grow over time. Since we use exponential discounting in future, it is mathematically easier to deal with exponential dynamics of hazard cost from global warming. The whole shape of future costs from oil peak is not clear for several reasons: There is also non-conventional oil (but also finite!) There is a possibility of technical transition for post-oil society (with biofuels and other renewable energy) That is why it is assumed that cost will be a dramatic shock (if oil peak will be observed with no immediate solution),but it will last for some finite time span (before solution is discovered). Given that we compare costs distributed over time, the discount rate becomes very important for policy. Yegorov, Uncertainty, St.Petersburg, SKISD

14 Cost of Global Warming. 1 The social cost from global warming is assumed to grow exponentially with power kt. Assume that economic growth will be with power bt, but cost of global warming will be subtracted. Then expected utility is given by: Suppose that k is uncertain and uniformly distributed on [k1,k2]. Then We focus on the case k2<r, when integral converges (there is always so high discount of future, for Russia especially). Yegorov, Uncertainty, St.Petersburg, SKISD

15 Cost of Global Warming. 2 It is useful to do some calibrations. If the global temperature can increase between 2 and 5 degrees Celcium over the 21 st century, what level of k does it impose? If harm is coming moderately, then we can assume 5 degrees increase can mean cost increase by factor e=2.71. Since k=1 means increase by factor e in 1 unit of time (year), an increase by factor e in 100 years requires multiplier Let us assume that in 100 years temperature increase will occur linearly in time and cumulatively on 5 degrees. Then k=a dt(t), and dt(t)=t(t)-t(0)=ct, where c=0.05 for pessimistic scenario of 5 degrees growth (and c=0.02 for optimistic scenario of 2 degrees growth) over a century. We have k=ac=0.01. For c=0.05 this gives a=0.2. Now we can fix a=0.2 and find that for optimistic scenario with c=0.02 we get k=ac= Thus for our moderate assumption of damage growth we get uncertain k between and Adding uncertainty on damage growth can only increase this range, let say, to 0.002<k<0.02. The interest rate r in developed countries is about 2%, while in Russia (and developing countries) it is about 10%. Both cases will be considered. Yegorov, Uncertainty, St.Petersburg, SKISD

16 The Hazard from Oil Peak Oilpeak will come in uncertain moment t* and will bring shock K. The transition to oil substitutes from renewable energies will take some time T. The overall utility with oil peak consequences is given by the integral: It can be calculated: Yegorov, Uncertainty, St.Petersburg, SKISD

17 Comparison of Both Hazards The hazard from both global warming and oil peak depends crucially on interest r. The hazard density will be shown on next two Fig. for different discount r. Fig. 1 shows hazard density with discount of 2%, while Fig. 2 does it for 10%. As we see from Fig.1 (relevant for OECD countries), the economic hazard from global warming has very low decline in time. This happens because of high variation of possible growth rates of damage over time. The hazard from oil peak is not much discounted, since it will come in few decades. But still it may happen that public opinion on the cost of global warming is higher. The values of cumulative hazard at Fig. 1 are comparable (0.228 vs 0.249). Still, it may happen that H gw < H op. The vision as on Fig.2 is typical for developing countries that are also exporters of oil. Contrary to the case of low discount (2%), the case of high discount sees little harm from oil peak (this is far away is time), but the hazard from global warming is also declining fast over time. Here we can have reverse: H gw > H op. Yegorov, Uncertainty, St.Petersburg, SKISD

18 h-gw, h-op Vision of Future Cost for r=2% (low discount) 0,060 Hazard densities for global warming and oil peak over time (r=2%) 0,050 0,040 0,030 h-gw h-op 0,020 0,010 0, Time, years Yegorov, Uncertainty, St.Petersburg, SKISD

19 h-gw, h-op Vision of Future Cost for r=10% (high discount) 0,0160 Hazard densities for global warming and oil peak over time (r=10%) 0,0140 0,0120 0,0100 0,0080 0,0060 h-gw h-op 0,0040 0,0020 0, Time, years Yegorov, Uncertainty, St.Petersburg, SKISD

20 Economic Implications First, we see that perceived expected harm from both oil peak and global warming depends on the believed path of future costs. We never experiences any of those yet (but when we will, it will be too late), but we might overestimate the danger from global warming. What will happen if the majority will believe that we should stop extracting fossil fuels (before they end) to combat global warming? The price of oil will not grow (or grow not much). Suppose now that our vision on global warming was too pessimistic (realized path of economic externalities grows not so fast over time), comparing to our vision of hazard from consequences of oil peak. Before oil peak we then treated oil as bad, and price of it was modest. Moreover, holders of oil reserves could have sold them to buyers (especially from OECD countries). They could rationalize such decision on the belief that some oil will never be extracted. When (after nee information arrives) the world revises the hazards, it starts to value oil at high extent, and its price sky-rockets. Yegorov, Uncertainty, St.Petersburg, SKISD

21 Conclusions The idea of this paper was to show how the owners of oil reserves can be fooled, if they underestimate the danger from oil peak and/or overestimate the hazard from global warming. We are playing global lottery game, with a lot of uncertainties (and even information manipulation). We have to understand how resource owners can be stripped from their assets. Another important issue (also highly relevant for Russia) is its high discount value. Even if we forget for a while about considered hazards, it is simply not rational to exploit oil in parity with Saudi Arabia, given that the latter have more oil resources in all scenarios. If Russian discount rate would jump from 10% to 2% (and even intermediate 5%), it would revise its production path, cut oil production and save it for future generations. Partly it will recover some current benefits from rising oil price. Yegorov, Uncertainty, St.Petersburg, SKISD

22 Thank you for your attention! Please write your comments to Yegorov, Uncertainty, St.Petersburg, SKISD