Tag Archives: Jeremy Grantham

Chart of the Day, 28 Jan 2015: Oil, Cornucopians, Peakists and Jeremy Grantham

The stunning collapse in oil and metal prices since last summer (see yesterday’s post) has brought the cornucopians and abundantites crawling out of the wood work. From an (otherwise very good) article in The Economist of 17th January titled “Let there be light”.

An increase in supply, a surprising resilience in production in troubled places such as Iraq and Libya, and the determination of Saudi Arabia and its Gulf allies not to sacrifice market share in the face of falling demand have led to a spectacular plunge in the oil price, which has fallen by half from its 2014 high. This has dealt a final blow to the notion of “peak oil”. There is no shortage of hydrocarbons in the Earth’s crust, and no sign that mankind is about to reach “peak technology” for extracting them.

Frankly, this is just sloppy thinking from The Economist: the second sentence, which talks of a “final blow” to the notion of peak oil, doesn’t follow on from the first.

In short, the paragraph muddles the short term and the long term. Why is a fall in oil prices barely six months’ old a “final blow” to the notion of peak oil? And while fracking shows we are far from “peak technology”, it says nothing about price. Can tight oil keep coming to market for years to come at current prices? I think not. For a longer treatment of oil supply versus oil demand, see my more detailed post titled “Has Shale Killed Peak Oil“.

One of the most vocal advocates of the ‘peakist’ or ‘depletist’ hypothesis is Jeremy Grantham, who has used The Quarterly Letter of GMO as a platform for his views. The chart below is taken from The Third Quarter 2014 letter (click for larger image):

U.S. Average Hourly Manufacturing Earnings:Oil Price per Barrel jpeg

Grantham points out that in 1940 one hour’s work for an American engaged in manufacturing could buy 20% 0f a barrel of oil. At the twin peaks of oil abundance–1972 and 1999–the same wage could buy over a barrel of oil. But those days, he argues, are long gone. According to Grantham, this has implications for not only oil markets but also for the energy underpinnings of global economic and productivity growth.

Yesterday, I also argued that the rapid slowing to the Chinese economy was the likely culprit behind the havoc in commodity markets rather than a breakthrough in one particular extraction technology. As evidence, I noted how iron ore and copper prices had collapsed along with the oil price, despite the fact that you can’t frack for copper and iron ore.

The critical question now is what will happen to supply in the face of sluggish demand. Tight oil production is dramatically different from traditional oil production due to the accelerated nature of the depreciation schedule. Fracked fields deplete quickly, so to maintain production you must continually invest. If you don’t, aggregate production falls fast–that is, within a year or two. So we won’t witness a decade long excess capacity work-out as you would have seen in previous oil price busts: supply should adjust to demand at breakneck speed this time around.

Consequently, while we are not at “peak technology” for oil extraction, we possibly are at “peak cheap technology”. If so, forget all talk of “final blows” to peak oil.

World GDP: No Slowdown—Yet

This blog broadly looks at three factors that could usher us into a post-growth world: climate change, resource depletion and diminishing returns to technology. Nonetheless, top-level data suggest that we have yet to arrive in this post-growth world.

As can be seen in the chart below (click for larger image), global GDP has been robust in recent decades, notwithstanding the slump in 2009. Advanced economy growth appears to be exhibiting a modest downward trend, but from an empirical standpoint it is too early to draw any firm conclusions.

World GDP jpeg

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Links for Week Ending 16th February

  • Professor Jim Hamilton is one of the few economists to give peak oil considerations a proper hearing. Moreover, as one of the world’s leading econometricians and author of the popular text book “Time Series Analysis” he cannot be accused of not knowing his numbers. This last week he has posted twice on oil (here and here) on his blog Econbrowser that he co-authors with Menzie Chin. Frequently, in any discussion of resource depletion, the standard economics response is that ‘price begets supply’. Hamilton points out that such logic only extends so far for an exhaustible resource
  • Dana Nuccitelli has a good post at Skeptical Science entitled “A Glimpse at Our Possible Future Climate, Best to Worst“. It delves into two of the major climate risk parameters: climate sensitivity and emission paths. Other major determinants of climate risk are changes in the carbon cycle, methane release and the extent of climate-related economic impacts themselves. And that is just the ‘known knowns’ and the ‘known unknowns’.
  • Veteran observer of the Chinese economy Michael Pettis has long argued that China’s supercharged growth rate is unsustainable. Here and here are recent restatements of his belief that we face a great re-balancing. This has major implications for both climate change-related CO2 emissions trajectories and resource depletion rates.
  • The Washington Post asks why monetary policy no longer works and economies fail to grow around the world. Personally, I think the answer is no longer solely to be found in the study of monetary and fiscal policy. Jeremy Grantham, the ever-thoughtful Chief Investment Strategist at GMO is squarely in my camp, with his firm predicating strategy on a U.S. long-term growth rate of 1.5%. Against this background his analogy is “of the Fed beating a donkey (the 1% growing economy) for not being a horse (Bernanke’s 3% growing economy)”. Read his last GMO letter on decelerating growth and the impact on investment here.
  • Grantham references an article by Chris Brightman of Research Affiliates which pegs long-term U.S. growth rates at 1% due to trends in population, employment and productivity. If true, and we then add in the impact of resource depletion and climate change over the next two decades (the pivot decades for me), we could easily be looking at a no-growth U.S. economy by 2030-2040.

Jeremy Grantham and Climate Change

I am sometimes amazed by how climate change has become almost a taboo issue in certain circles of the investment community. For example, John Mauldin, who writes Thoughts from the Frontline, probably the most-widely circulated and read financial newsletter in the world, barely touches on the issue. Is he a skeptic? My sense is ‘yes’ based on his musing on volcanoes in his 2011 New Year piece, although it is difficult to tell.

Yet regardless of his own inclination,  my suspicion is that John has decided to ignore climate change for fear of upsetting his readership base, given the political polarisation that the issues produces. Paraphrasing Oscar Wilde, climate change has become the investment topic that dares not speak its name. It is therefore refreshing to find at least one high profile investment manager who is not afraid to take a very public stand on the issue: Jeremy Grantham.

In the GMO Quarterly Letter written in July 2010, Grantham came out with one of most succinct explanations of global warming for investment professionals I have seen under the title “Everything You Need to Know about Global Warming in 5 Minutes”. It is worth spending 5 minutes of your time to read it through:

1) The amount of carbon dioxide (CO2) in the atmosphere, after at least several thousand years of being quite constant, started to rise with the advent of the Industrial Revolution. It has increased by 40% and is rising each year. This is certain and straight forward.

2) One of the properties of CO2 is that it creates a greenhouse effect and, other things being equal, causes the temperature to rise. This is just physics.

3) Several other factors, like changes in solar output, have major influences on climate over millennia, but these effects are known, are observable, and have been allowed for in current models. Critically, there have been no important changes in these other factors over the last 100 years.

4) The doubts arise when it comes to the interaction of CO2 with other variables in a complicated system, especially water vapor. It is impossible to be sure whether the temperature will rise slowly or rapidly. But, the past can be measured. The temperature has indeed steadily risen and is well within the boundaries predicted for the man-made effect. But the forecasts still range very widely, from a harmless negligible rise to a potentially disastrous +6 degrees Fahrenheit or higher within this century. The main danger of the CO2 interaction with water vapor is the high probability that it will cause a great increase in severe precipitation episodes.

5) Skeptics argue that this wide range of uncertainty lowers the need to act: “Why spend money when you’re not certain?” But since the penalties rise hyperbolically at the tail, a wider range implies a greater risk (and a greater expected value of the costs). This is logically and mathematically rigorous and yet is still argued.

6) Pascal asks the question: What is the expected value of a very small chance of an infinite loss? And, he answers, “Infinite.” In this example, what is the cost of lowering CO2 output and having the long-term effect of increasing CO2 turn out to be nominal? The cost appears to be equal to foregoing, once in your life, six months’ to one year’s global growth – 2% to 4%, or less. The benefits, even with no warming, include: energy independence from the Middle East; more jobs, since wind and solar power and increased efficiency are more labor-intensive than another coal-fired power plant; less pollution of streams and air; and an early leadership role for the U.S. in industries that will inevitably become important. Conversely, what are the costs of not acting on prevention when the results turn out to be serious: costs that may dwarf those for prevention; and probable political destabilization from droughts, famine, mass migrations, and even war. And, to Pascal’s real point, what might be the cost at the very extreme end of the distribution: definitely life changing, possibly life threatening.

7) The biggest cost of all from global warming is likely to be the accumulated loss of biodiversity. This features nowhere in economic cost-benefit analysis because, not surprisingly, it is hard to put a price on that which is priceless. 

8.) A special word on the right-leaning think tanks: As libertarians, they abhor the need for government spending or even governmental leadership, which in their opinion is best left to private enterprise. In general, this may be an excellent idea. But global warming is a classic tragedy of the commons – seeking your own individual advantage, for once, does not lead to the common good, and the problem desperately needs government leadership and regulation. Sensing this, these think tanks have allowed their drive for desirable policy to trump science. Not a good idea.

9) Also, I should make a brief note to my own group – die-hard contrarians. Dear fellow contrarians, I know the majority is usually wrong in the behavioral jungle of the stock market. And heaven knows I have seen the soft scientists who lead finance theory attempt to bully their way to a uniform acceptance of the bankrupt theory of rational expectations and market efficiency. But climate warming involves hard science. The two most prestigious bastions of hard science are the National Academy in the U.S. and the Royal Society in the U.K., to which Isaac Newton and the rest of that huge 18th century cohort of brilliant scientists belonged. The presidents of both societies wrote a note recently, emphasizing the seriousness of the climate problem and that it was man-made. (See the attachment to last quarter’s Letter.) Both societies have also made full reports on behalf of their membership stating the same. Do we believe the whole elite of science is in a conspiracy? At some point in the development of a scientific truth, contrarians risk becoming flat earthers.

10) Conspiracy theorists claim to believe that global warming is a carefully constructed hoax driven by scientists desperate for … what? Being needled by nonscientific newspaper reports, by blogs, and by right-wing politicians and think tanks? Most hard scientists hate themselves or their colleagues for being in the news. Being a climate scientist spokesman has already become a hindrance to an academic career, including tenure. I have a much simpler but plausible “conspiracy theory”: that fossil energy companies, driven by the need to protect hundreds of billions of dollars of profits, encourage obfuscation of the inconvenient scientific results.

11) Why are we arguing the issue? Challenging vested interests as powerful as the oil and coal lobbies was never going to be easy. Scientists are not naturally aggressive defenders of arguments. In short, they are conservatives by training: never, ever risk overstating your ideas. The skeptics are far, far more determined and expert propagandists to boot. They are also well-funded. That smoking caused cancer was obfuscated deliberately and effectively for 20 years at a cost of hundreds of thousands of extra deaths. We know that for certain now, yet those who caused this fatal delay have never been held accountable. The profits of the oil and coal industry make tobacco’s resources look like a rounding error. In one notable case, the obfuscators of global warming actually use one MIT professor who also defended tobacco! The obfuscators’ simple and direct motivation – making money in the near term, which anyone can relate to – combined with their resources and, as it turns out, propaganda talents, have meant that we are arguing the science long after it has been nailed down. I, for one, admire them for their P.R. skills, while wondering, as always: “Have they no grandchildren?”

12) Almost no one wants to change. The long-established status quo is very comfortable, and we are used to its deficiencies. But for this problem we must change. This is never easy.

13) Almost everyone wants to hear good news. They want to believe that dangerous global warming is a hoax. They, therefore, desperately want to believe the skeptics. This is a problem for all of us.

And Grantham has not been shy of putting his money where his mouth is—not least through funding the Grantham Institute for Climate Change at Imperial College and the Grantham Research Institute on Climate Change and the Environment at the London School of Economics.

The New York Times has just published an article entitled “Can Jeremy Grantham Profit from Ecological Mayhem” that I hope will introduce Grantham’s views to a wider audience. The title of the article is somewhat deceptive to the degree that Grantham’s charitable actions aim to prevent ecological mayhem. But what is new in the article is Grantham’s proposal that climate change should be recast as a resource issue to gain some political traction. In his own words:

“Global warming is bad news. Finite resources is investment advice.”

Personally, I believe that climate change can be sold as a financial threat from a variety of angles.  To the question “Have they no grandchildren?”, I think the answer is “Yes they do”. And the grandchildren will take a variety of hits. Some via climate-induced resource limitations bearing down on economic growth, and some through direct hits via sea level rise and extreme weather events. In the final analysis, those ignorant of global warming will see their wealth, and wealth of their families, transferred to those who are informed.