Battle of the Titans - Oil vs Insurance
By Melvin J. Howard
Will it be easy being green when everybody wants to be in the
black! We'll discuss the relationship between black gold, the future of the
world's most powerful cartel, the changing climate and the powerful industry
that loses big bucks on bad weather.
First we'll discuss that ever important "oil price
range" that target price range per barrel of oil within which both
producers and consumers are happy to continue "business as usual".
But we can't discuss that without also talking about that thing at the heart of
the oil markets so despised in all our free market teachings the cartel in this
case, the OPEC cartel, of course. Given what's happened in Iraq and continuing
US policy towards OPEC countries, we'll see where OPEC might be headed in the
future.
We'll look at the indications that the OPEC cartel may face tough
times ahead and the outlook for the fossil fuel industry in general. For, while
they might be thinking their future looks pretty rosy, they may be just about
to meet their match. You see, what has now become "old Europe" is
also the home of another fearsome and ancient creature of the capital markets
that is none too pleased about the world's use of fossil fuels. Despite
skepticism, the huge global insurers and reinsurers accept climate change as
fact. Furthermore, they accept that climate change is induced by human
activity. And, climate change is costing them big bucks. As powerful advocates
of the Kyoto Protocol and with Trillions of dollars to vote with in the capital
markets, the insurance industry has both the motive and the power to do
something about climate change.
A cartel is formed when a dominant group of suppliers or producers
of a product conspire to keep prices artificially high. Basically, they
conspire to hold back supply so that prices are held above where they would
fall if you allowed full competition between these producers. The most powerful
cartel in the world is, of course, OPEC the Organization of Petroleum Exporting
Countries. It consists of 11 countries altogether and they are Saudi Arabia,
Iran, Iraq, Qatar, UAE, Kuwait, Nigeria, Algeria, Lybia, Indonesia and
Venezuela. For various reasons, OPEC does not want the price of oil to get too
high, either. And so the price of oil ends up being managed within a certain
magical price range. What is that magical price range?
What will happen to it now that America the worlds largest oil
consumer is running the place?" Isn't it bizarre that, for the first time
ever in the history of big cartels, the biggest customer of the cartel, the
United States, actually has a seat at the table of the cartel? These days, it's
not just the environmental movement and some concerned shareholders going into
battle against the oil giants. Another set of equally formidable industry
giants the global reinsurance companies are starting to flex their muscles in
this global battle for green fuels over fossil fuels. Reinsurance companies
basically provide insurance to the direct insurance companies that we are more
familiar with, who insure our houses, cars and businesses. The two biggest of
these the European based Swiss Re and Munich Re - provide insurance to
insurance companies all over the world, to limit the losses of those insurance
companies, just like we limit out losses by buying insurance on our house.
Billionaire investor Warren Buffett has taken a 3% stake in Swiss Re, the
world's largest reinsurer.
Buffet's investment company, Berkshire Hathaway, acquired the
11.25 million shares on the open market through its subsidiary Columbia
Insurance. Swiss Re said in November that it expected to post a full-year net
profit for 2007 despite the need to take writedowns because of exposure to the
subprime mortgage crisis. Just like you have to go to Texas to talk oil, you
have to go to Switzerland and Germany to talk about important worldly insurance
issues. Apparently, not all insurers are quite so active in this mission to
stem climate change, and it seems that some of the US insurance companies are
not so serious about slaying the fossil fuel dragon.
Quite undeterred by the finding of the UN Panel on Climate Change
and the 30 years of study at the big reinsurers, some consultants and
researchers in the oil industry are determined to believe that fossil fuels do
not cause climate change.
Many oil industry analysts see the demand for, and use of, oil
continuing to increase for decades to come and can't see how transportation can
get away from the fossil fuels. But, then again, so people with wood chip cars
and buses early in the twentieth century might have once thought about their
dependence on chopping down trees for transport. Where is the status of renewable
energy to some people's amazement, the environmental community is starting to
work more with the investment community in the battle against global warming. Most
developed nations have now ratified the Kyoto Protocol of the United Nations
Framework Convention on Climate Change, including all 25 member states of the
European Union, as well as Canada and Japan. By ratifying the Kyoto Protocol on
climate change, these countries have pledged to reduce their greenhouse gas
emissions by a significant amount over the next decade.
Just like with the water cycle, in the carbon cycle, only a tiny
fraction of carbon on earth actually participates in the carbon cycle relevant
to us terrestrial creatures. And just like the water cycle, any carbon we have
in our bodies today has certainly done the rounds over thousands or millions of
years: through plants, soils, other animals, the ocean and the atmosphere. And
you can forget property rights when it comes to carbon! When the carbon in us
is ready to depart, it will just go off and be somewhere else. Before the
industrial revolution got underway, global carbon flows ran as follows: Carbon
in the air, stored as carbon dioxide (amongst other gases), is used by plants
in photosynthesis and becomes part of the plant. Some of these plants get eaten
by animals and the carbon in them is then used in various molecules to make
body tissue and to burn up energy. Other plants, or parts of them, like leaves,
just get old and die.
This decomposition releases some carbon back to the
atmosphere, as does the process of respiration by animals. The other 99.9
Before fossil fuel use by humans entered the scene, losses of carbon from the
earth and into the air from decaying vegetation and animal respiration, in the
form of various gases such as carbon dioxide and methane, were pretty much
balanced by carbon storage or "sequestration" by plants during
photosynthesis. The carbon cycle chugged along in this balance between about
1000 AD and the early 1800s, and so the amount of carbon in the air stayed pretty
constant over this time period since the middle ages. To give you an idea of
magnitude, this annual exchange was about 100 million gigatons of carbon (where
a gigaton is a billion tons), from the earth into the atmosphere, balanced by
an equal exchange from the atmosphere back to the earth. But then came the
industrial revolution, powered by the burning of carbon rich fossil fuels, and
accompanied by massive clearing of forest land for agricultural and other
purposes.
These two activities have extracted another 7-8 gigatons of carbon
out of the earth's sources per year, of which the oceans and the world's
forests have decided to absorb just over half of this release. So the remaining
3-4 gigatons of carbon has nowhere to go but into the air. Over the past 200
years, the level of carbon dioxide in the atmosphere has risen by 30 An excess
of carbon gases, like carbon dioxide and methane, are known to trap heat in the
biosphere, making things toastier for all of us. This so-called "global
warming" has many known and unknown impacts on climate.
That humans have significantly increased the amount of carbon
gases in the atmosphere, and that these gases do contribute to temperature
increases is generally not in dispute between the two main parties on either
side of the Kyoto Protocol. What is under debate is the degree to which global
warming is caused by natural versus man-made factors. The fairly recently
discovered indications that the middle ages may have been warmer than the
current ages. Satisfied that human activities are contributing to climate
change, the countries that have now ratified the 1997 Kyoto Protocol on global
warming are trying to do what they can to get as much as possible of this
excess carbon out of the atmosphere by implementing mechanisms designed to
reduce overall carbon emissions.
The reluctant side are diverting significant resources into
figuring out how carbon wastes can be buried underground or in the sea in a
process known as artificial carbon sequestration.
The
First International Carbon Market
Sure, international markets for various forms of carbon products
already exist. There are markets for diamonds, graphite, wood products and, of
course, fossil fuels themselves. But now there's a new carbon market. In this
new carbon market a monetary value is assigned to a carbon gas emission
allowance. Such an allowance could only have a monetary value if there are a
finite number of such emission allowances and the total amount allowed in the
market is close to, or even below, the total amount that is currently being
emitted. For this market to exist in the first place there must be someone or somebody,
most likely a government body that sets the total number of allowances for the
market.
This is exactly what the European Union has done. It has used the
"cap and trade" approach to moving towards Kyoto targets, which for
the EU, requires greenhouse emissions to get to 92 As announced on July 23rd
2003, the European Commission has formally adopted a market structure for a
"cap and trade system" for carbon dioxide emissions that will begin
operations at the start of 2005. Under the EU emissions trading scheme the EU
member states will set limits on carbon dioxide emissions from energy intensive
companies by issuing allowances for the amount of gas each is allowed to emit.
The total number of allowances will reduce each year until the final target is
reached. This list of companies includes approximately 10,000 companies accounting
for about half of the EU's cabon dioxide emissions and encompasses the
following industries: steel, power generation, oil, paper, glass and cement.
A company that is able to lower its emissions at relatively low
cost, may sell its excess allowances and hence, the argument goes, the
emissions market will act as a catalyst towards finding lowest cost emissions
reduction solutions. Other companies that have difficulty meeting their targets
inexpensively can buy these excess credits in the market, at whatever the
prevailing market price is. In effect then, they are providing the financing to
the seller of the credits for the seller's emissions reductions efforts, since
this was cheaper than reducing emissions in their own operations. And, if companies
decide to neither meet their targets nor buy credits in the market to offset
their excess, they will have to pay large fines to the government, well in
excess of the market price of credits. Hence the incentives are there for
companies to either comply or buy credits, thus ensuring that the total amount
of emissions will remain below the target.
This method of allowing the market to cut emissions quickly where
it is cheapest and easiest to do will presumably have the least detrimental
effect on the health of the economy. As I am a free marketer to the very core I
am also very mindful of the our environment that is what Quantumnomics is all
about using the market and science to solve society most complex issues.
It does seem like some kind of miracle that a bunch of 25
countries as diverse as the European Union and who were at war with each other
not so long ago, could unite over a proposal that is bound to bring some shocks
to their local economies. Even the European environmental community seems fairly
pleased with the EU's approach to global warming. But, like all such complex
agreements involving so many and varied parties and lots of different political
interests, this one is not without controversy or room for abuse.
During the discussions leading up to the 1997 Kyoto Protocol, some
of the most controversial provisions had to do with the ways in which companies
and/or countries could accumulate excess greenhouse gas credits other than by
cutting emissions below their target level. Some of these so-called "Kyoto
Mechanisms" included:
Creating "Carbon Sinks": Such as planting new forests,
or even certain types of timber farming Joint Implementation Projects: Which
means funding emission reductions projects in other industrialized nations Clean
Development Mechanisms: Which means funding "clean energy" projects
in developing nations. Many people fear that credit accumulation or emissions
offsets gained under these methods may be the most wide open for abuse and
therefore may not bring about real change in the battle to stem the release of
greenhouse gases into the atmosphere.
The recently approved EU Emissions Trading Scheme, begin trading
in 2005 did not provide for these Kyoto Mechanisms. However, a recent Directive
proposes an amendment allowing two of these mechanisms - Joint Implementation
and Clean Development Mechanism Projects in other countries - as methods to
accumulate carbon emissions credits. Climate Action Network in Brussels
discusses their concerns about these mechanims. Nevertheless, these
developments in Europe have really made the EU the world leader in trying to
stem man-made contributions to climate change.
The United Kingdom set up the first national emissions market of
its own, similar to the EU "cap and trade" mechanism. The UK actually
plans to significantly exceed, or do better than, its Kyoto targets by the end
of the decade and they have gone further than just capping, trading and fining
violators. In 2001 the British government imposed a Climate Change Levy in the
form of a tax on business use of fossil fuel based energy sources. Relief on
this tax can be gained by meeting certain targets in the emissions trading
program. Different countries face very different challenges in meeting their
Kyoto targets. For less populated and more agricultural-dependent countries
like Australia and New Zealand, carbon dioxide emissions from fossil fuel use
are not the main problem areas.
Though one doesn't like to talk about these things in polite
company, believe it or not, cow and sheep burps and farts are a much bigger
problem! Cattle and sheep grazing and their subsequent emissions of smelly
gases as by-products of the digestive process, contribute an abundance of the
most potent of the greenhouse gases - methane. In fact, farm animal farts and
burps account for about one half of all greenhouse gas emissions in New
Zealand.
Unlike its less cooperative neighbor Australia, the country of New
Zealand has ratified the Kyoto Protocol and had to do something about these
smelly air bubbles. In a move that was far less socially acceptable than either
the poops themselves or Britain's Climate Change Levy, the New Zealand
government took the drastic step of taxing farmers for the natural bodily
functions of their farm stock they introduced the world's first tax on farting!
Yep you read it right farting a farmer's rebellion got underway immediately and
it is unclear what will happen next. Across the Tasman pond, Australia has some
similar problems, but more broadly faces the reality that greenhouse emissions
have increased over the last decade primarily due to land use changes,
including deforestation and agricultural practices. As forest land is cleared
and burned to make way for agricultural and other uses, and under certain types
of agricultural practices, much carbon that was stored in plants and soils is
released back into the atmosphere.
This feature of Australia's greenhouse gas profile appeared to be
partly responsible for a flurry of activity witnessed at the Sydney Futures Exchange
in the late 1990s as Australia was about to develop the world's first
derivatives market for carbon credits. Working with the State of New South
Wales Forestry Department and also closely with the forest investment divisions
of global financial institutions such as the US-based John Hancock Insurance
Company, the stage was set for the first international market in carbon
futures, backed by the trees in new and growing forests in Australia. These
carbon-based instruments were to be based on the quite controversial provision
in the Kyoto Protocol whereby "Carbon Sinks" such as certain forests
and forest management practices, can be used to accumulate credits in carbon
emissions trading programs. However, this world-first futures market collapsed
by the year 2000, mainly due to the controversial nature and uncertainties
surrounding the definition of Kyoto Forests and Carbon Sinks. It also didn’t
help matters that Australia failed to ratify the Kyoto Protocol.The Kyoto Protocol is now official international law.
As the EU was announcing its implementation of the world's first
International Carbon Markets, the Bush Administration on July 25, 2003
("Wall Street Journal") announced a new $100 million climate change
research plan. This project will deploy satellites and other technology to
primarily study natural causes of climate change, particularly the role of
clouds.
If this fails to prove that global warming is all Mother Nature's
fault, well, there is one more thing you can do without having to cut down on
fossil fuels - and that's to bury the extra greenhouse gases. A collection of
countries, led by the US and Australia, are cooperating on finding ways to
sweep our extra greenhouse gases under the proverbial rug so to speak.
As the carbon markets emerge in other countries, you can expect to
see the US-based investment banks and brokers getting involved, despite the
fact that the US is not a signatory to the Kyoto Protocol. You can also expect
some rumbles from multi-national companies based in Europe that also do a lot
of business in the US. Furthermore, the companies that have to start complying
with the European rules and who are spending money to comply, will be able to
green wash their image with some legitimacy. This, in conjunction with growing
shareholder activism on climate change in the US may apply significant pressure
for change in this country. It is likely that even US based companies across
the financial, energy, and other sectors will be significantly impacted by the
Kyoto Protocol, even without ratification by the US. There may also be a
concern from many companies that they are missing out on opportunities in new
markets, such as the carbon markets and new energy markets, because the US is
not a party to the agreement.
