Chart of the Day, 30 Jan 2015: Pick a Pathway (to Climate Nirvana or Climate Hell)

After yesterday’s post on China’s emissions, I will try to keep in a ‘cup half full’ frame of mind today.

The Intergovernmental Panel on Climate Change (IPCC) is an organisation for which I have great respect. But while their research may be applauded for its rigour,  communication with the wider world frequently lacks clarity (to put it mildly). Take, for example, the emissions scenarios, which in the Fifth Assessment Report (AR5) are called Representative Concentration Pathways (RCPs). Here are the RCPs and the change in temperature that accompanies them (Source: IPCC AR5, WG1).

Global Mean Temperature Change jpeg

I have spent many an hour grinding through IPCC reports trying to find clear explanations of what sits behind these pathways, but it is a painful process. Eventually, Skeptical Science saved the day by publishing “The Beginner’s Guide to Representative Concentration Pathways“.

There are four Representative Concentration Pathways: RCP 8.5, RPC 6, RCP 4.5 and RCP 2.6. The numbers refer to what is termed the ‘radiative forcing’, the change in net energy flow as measured in watts per square metre. Moreover, RCP 8.5 is expected to keep on increasing past 2100, RCP 6 and 4.5 will peak in 2100 and RCP 2.6 will have peaked prior to 21oo. Simplistically, a larger forcing means the globe will reach a higher mean temperature, as you can see in the chart above.

Surprisingly, AR5 is not particularly concerned with the socioeconomic assumptions that lie behind the RCPs. In this respect, the climate scientists behind the RCP concept are thinking the way economists often do: they are saying “imagine if we had condition X, what would be the output Y”. In this way, you can explore the model, and, hopefully, you obtain some insight which you can then take back to the real world.

I’m still a little uncomfortable with this. I think the IPCC should have chosen RCPs with highly transparent assumptions and realistic story lines. Instead, two of the four RCPs look utterly unrealistic to me. For example, to get to RCP 2.6 would require a transition away from fossil fuels that now looks impossible. And the good news? Well, RCP 8 looks barking mad to me too. Here are the emissions trajectories (from the Skeptical Science RCP report; click for larger image):

RCP Emission Trajectories jpeg

And if you concentrate on the blue line in the CO2 chart, you can see that around 24 giga tonnes of carbon are expected to be emitted in 2060. In yesterday’s blog post I was on working in units of tonnes of CO2. In the above chart, while the subject is CO2, the y-axis is in carbon. For those who have forgotten high school chemistry, you have to remember this:

CO2 jpeg

So when we move from calculations working in tonnes of carbon to tonnes of CO2 we have to multiple by 3.67 (44 ÷12) and vice versa. Joe Romm had a great piece in Climate Progress a while ago highlighting the number of people who get caught out through mixing up CO2 and carbon units. Accordingly, the 24 giga tonnes of carbon in 2060 is equivalent to about 88 giga tonnes of CO2. To put this in perspective, what are the big emitters putting out today:

Regional Emissions to 2019 jpeg

European emissions are already in decline and US emissions are flatlining. China’s emission growth will decelerate because its fixed-investment driven GDP growth model will come to the end of its natural life. China is also just about to enter its own demographic transition, and we have all see what such a transition did to Japanese economic growth (and by extension its emissions).

Obviously, India and other developing nations will increase their emissions, but they are unlikely to be able to replicate China’s export-led growth model. Further, with every passing year, the grid parity of renewables falls. Prime Minister Modi announced a push toward renewables when meeting President Obama. This was not just as a diplomatic gesture ahead of the Paris climate talks, but also as a pragmatic measure to buttress India’s energy independence and reduce the country’s exposure to volatile fossil fuel price movements.

So the cup half full is that RCP 8 looks unlikely–but the cup half empty is that RCP 6.5 is pretty awful climate-wise all the same.

Chart of the Day, 29 Jan 2015: China Slowdown a CO2 Emissions Silver Lining

If you follow the climate change debate over time, it is difficult not to get depressed: it’s the feeling of helplessness as the slow-motion cash crash takes place before your eyes.

So when a little bit of light shines through, it comes as a relief. And sometimes, hope comes from the most unlikely of sources–in this case China. It is almost a truism that as go China’s CO2 emissions, so go the world’s. See the chart below (Source: Trends in Global C02 Emissions Report; click for larger image):

Global CO2 Emissions jpeg

Very roughly, global CO2 emissions have gone from around 24 billion tonnes per annum in the early 1990s to around 36 billion tonnes today: an increase of 12 billion, or 50%.

Taking the top six emitters, we see can China’s prime role in this growth more clearly (click for larger image):

Top 6 Emitters jpeg

So we have seen China move from emitting around three billion tonnes of CO2 in the 1990s to around 10 billion tonnes today. Thus of the extra 12 billion tonnes of CO2 emitted per annum globally after 20 years, 7 billion has come from China.

The Global Carbon Project sees emissions continuing to grow to 43 billion tonnes in 2019 (note giga is equivalent to billion).

CO2 Emissions to 2019 jpeg

And again it is China leading the trend:

Regional Emissions to 2019 jpeg

And keep in mind that we have a CO2 budget of around 1,200 billion tonnes of CO2 before we commit the earth to 2 degrees Celsius of warming with a 66% probability. On current trends, that budget will be used up by about 2041, or in around 27 years.

Carbon Budget 2014 jpeg

Over that period, China is likely to emit approximately 15 billion tonnes of CO2 per year on average on present trends. That would mean that by 2041, China would have emitted about 400 billion tonnes of CO2, or a third of the total budget available. Next question: is there any way China can free up more of the budget?

A paper by Luukkanen et al provides us with a detailed decomposition of China’s future emissions using a Kaya identify with a sectoral overlay. To refresh your memory, the Kaya identity allows us to estimate future emissions based on population growth, GDP growth per person, energy intensity per unit of GDP, and carbon intensity per unit of energy (see my post “The Unbearable Logic of the Kaya Identity” for a little more detail).

The paper sets out three fuel-related emission scenarios: reference (business as usual), policy (following the government’s developmental plans) and industry (a  focus on heavy industry and investment-led growth).

China CO2 Scenarios jpeg

Note that the above charts are only looking at fuel combustion emissions. Accordingly, these numbers don’t tally with the Global Carbon Budget numbers that also add in agriculture and industry-related emissions. Nonetheless, where fuel emissions go, so will total emissions.

Here is where the silver lining comes: the most-muted emissions scenario above, termed ‘policy’, still looks far too high growth-oriented to me. Here are the assumptions that underpin this scenario `click for larger image):

China Sectoral Annual Growth Rates jpeg

In the policy scenario, a GDP growth rate of 7.4% is still forecast between 2016 and 2020, and then 5.2% growth  between 2021 and 2030. If you believe in a much quicker slow-down scenario, which I do, then these numbers look hopelessly optimistic (from a growth rather than climate perspective). See my post referring to Michael Pettis’ work.

If you then combine a much swifter descent to growth rates of 3-5%, plus a continued pivot from investment-led growth to consumption-led growth, and then add on an aggressive renewables roll out (which we are seeing), then China could free up an additional 100 billion tonnes of the carbon budget.

Frankly, that still doesn’t get us anywhere near capping climate change to 2 degrees of warming, but it gives us a little bit of extra time. And given where we are, every little bit helps.

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.

Chart of the Day, 27 Jan 2015: What Is Dr Copper Trying to Tell Us?

Many have been transfixed by the collapse in the price of oil, but that downturn has been paced by what is going on with copper and iron ore. Note: you can’t frack for copper (click for larger image):

Historical Price on Copper jpeg

And since the beginning of January, things have speeded up:

30 Day Copper Price jpeg

In market lore, copper is dubbed the metal with a Phd in economics due its reputed ability to portend the coming of recessions. But given China’s outsized role in providing almost all incremental demand for the commodity complex, is Dr Copper just signalling a hard-landing in China?

One observer who flagged this development well in advance is Michael Pettis, a professor of finance who blogs at China Financial Markets. Pettis wrote a piece entitled “By 2015 Hard Commodity Prices Will Have Collapsed” in September 2012 (here), in which he gave four reasons for his forecast:

  1. Supply was being massively ramped up, but with a substantial lag relative to demand
  2. The incremental increase in demand was almost all from China
  3. The Chinese growth model is severely imbalanced, being overly fixed investment, and so commodity, intensive
  4. Chinese inventories have also spiralled out of control

Pettis has long argued that countries that maintain repressive, or skewed, financial regimes that over-emphasise investment always hit a brick wall. Prime exhibits for this thesis are the Soviet Union and Japan. Moreover, the longer you pump up growth with state-directed credit, the more bone-crunching the final adjustment will be. This is what he said back in 2012:

The consensus on expected economic growth among Chinese and foreign economist living in China has already declined sharply in the past few years. From 8-10% just two years ago, the consensus for average growth rates in China over the next decade has dropped to 5-7%. But the historical precedents suggest we should be wary even of these lower estimates. Throughout the last 100 years countries that have enjoyed investment-driven growth miracles have always had much more difficult adjustments than even the greatest skeptics had predicted.

And further on in the article:

The current consensus for Chinese growth over the next decade is almost certainly too high. Even if Beijing is able to keep household income growing at the same pace it has grown during the past decade, when Chinese and global conditions were as good as they ever could be, it will prove almost impossible for the economy to rebalance at average GDP growth rates over the next decade of much above 3 percent.

Moving closer to the present day, Pettis published a thoughtful piece last month titled “How might a China slowdown affect the world?”. In the post he restates his China hard-landing scenario–nothing new there. However, he goes on to question the common description of China as the world’s ‘growth engine’.

For him, while this characterisation may be true when disaggregating the main contributors to global GDP growth, it does not correctly describe China’s role in stimulating growth in other economies. Indeed, China is more a deflationary force at present, since the suppression of consumption and the continued expansion of production have led to successive current account surpluses and a surfeit of savings seeking a home abroad.

Should the descent from GDP growth rates of 10% plus down to 3 or 4% within a decade take place in an orderly manner, it is possible that the economy could rebalance, consumption pick up and savings fall. The net effect would be mildly positive for the global economy. Should a hard landing be accompanied by chaos in the credit markets, you could see households actually increase savings and the authorities crash the yuan in a desperate attempt to use export demand to absorb excess capacity. China would then transform from being a minor deflationary influence to become a deflation monster. Nonetheless, Pettis errs on the side of optimism:

A slowing Chinese economy might be good or bad for the world, depending on how it affects the relationship between domestic savings and domestic investment, and this itself depends on whether Beijing drives the rebalancing process in an orderly way or is forced into a disorderly rebalancing by excess debt. My best guess is that Beijing will drive an orderly rebalancing of the Chinese economy, even as it drives growth rates down to levels that most analysts would find unexpectedly low, and this will be net positive for the global economy.

I am not so sure.

Chart of the Day, 26 Jan 2015: End of Greek Austerity?

So can Greece’s Syriza Party end austerity?  At least it starts with government finances in pretty good shape (Source: European Economic Forecast, Autumn 2014; click for larger image).

Greek Government Expenditures jpeg

Already, the Greek budget is showing a positive primary balance; that is, expenditures before interest payments are less than revenue. So if the government didn’t pay interest to its debtors, it could spend more on welfare. But we are not talking about a lot of money here: a few billion euro at most. Alexis Tsipras, Syriza’s leader, likes to point out that Greece still has an awful lot of debt even after the restructuring by the Troika (the European Commission, European Central Bank and IMF), but the debt that it has is very, very cheap.

Nonetheless, according to the EU forecast, Greece is poised to show an overall budget surplus even after interest payments in 2015. The purpose of this surplus is supposed to be to pay down the debt mountain. But if the Greek government won’t do that, then they would have even more to spend. So far so good. But actually what we obtain from these measures alone is still a government running along very Germanic lines; in short, only spending what it earns. Hardly a revolution.

Let’s look at a breakdown of general government operations in more detail (from the IMF’s Fifth Review of its funding facility; click for larger image)

Greek General Govt Operations jpeg

The pictures of poverty on Greek streets comes about through a combination of 25% unemployment and a safety net shrunken by the fall in social benefits from €47.2 billion in 2011 to ¢38.1 billion in 2014. If you ran the primary balance at zero in 2015 and growth stayed on the same course as the IMF projection, then Syriza may be able to restore a little over half of the social benefit cuts. Then each year after that (still assuming GDP growth holds up) you could claw back some more.

This, however, would do little to jump start the economy. To do that in a Franklin D. Roosevelt New Deal kind of way you would need to see a massive jump in public works spending (the lines in the chart above showing investment and compensation of employees ). But on the assumption that Syriza has defaulted on its debts, it will, at least for a time, be shut out of the capital markets, so it will be in no position to borrow to spend.

A good Keynesian like Paul Krugman would argue that 25% unemployment is incontrovertible proof of a massive gap between potential and actual economic output. In such a situation, the government should let the central bank buy its debt (through printing money), so allowing public spending to let rip. The risk that this raises inflation when you have massive underutilized resources is close to zero. But Syriza can’t do that since it doesn’t have a central bank to call its own; Syriza’s central bank, the European Central Bank, resides in Frankfurt, not in Athens. In short, it can’t print and spend.

How about redistribution? Are the Greek oligarchs quaking in their boots? Again the euro  restricts the government’s options. With no exchange controls and a common currency, the rich have maximum flexibility to flee as and when they wish.

Perhaps, this is why financial markets have reacted to the Syriza victory with such equanimity. For them, Tsipras may possibly be the Red Emperor with no clothes. Unless, of course, he drops the big one: a euro exit. Now that is what I would call a revolution.

Chart of the Day: 25 Jan 2015: Capitalism and the Asian Middle Classes

As you may have guessed, I have strong sympathies with those advocating a green agenda. Further, the existing domination of neo-liberal thought within the policy elites (almost everywhere) means that capitalism has gone global. While the planet has been a loser in this process because of the pathetic response to global warming, we must not forget that there are winners.

I’ve blogged on Branko Milanovic’s work on inequality before, but here is one of his charts again (source here; click for larger image):

Percentile of Global Income Distribution jpeg

The United States skilled working and middle class, who were the target of President Obama’s latest State of the Union Address, sit around the 80% percentile of the global income distribution. For them, life has not got better; indeed, since the end point of the data in this chart, 2008, things have got worse.

But below them lie a mass of Chinese and Indians who have done very well out of global capitalism. We may want to highlight downtrodden textile workers in Bangladesh or displaced farmers in Ethiopia, but they are a minority. In Milanovic’s words (here):

Nine out of ten people around the global median, the “winners” of globalization, are from “resurgent Asia.” They are people from rural China, including some 150 million who have seen their real incomes increase by a factor of 2.5; rural and urban Indonesia, 40 million people whose real incomes doubled; or urban India, 35 million people with increases in excess of 50 percent. There are also workers from Vietnam, Philippines and Thailand. These “winners” belong to the middle or upper parts of their own countries’ income distributions.

This process has shifted economic power eastwards. The boxes in the charts below represent the size of the economies. Note how 50 years ago China, India and Indonesia were bit players in the global economy. How the world has changed (taken from the McKinsey report “Can global growth be saved” I referenced last week; click for larger image):

Per Capital GDP jpeg

Critiques of the world economic order–with respect to sustainability or any other issue–have to recognise the fact that many, many people have done very well.

Chart of the Day, 24 January 2015: The EU, QE and an Old Age Issue

This is going to be wonkish, but it’s important–so bear with me. I’m going to talk briefly about the EU’s new turbocharged quantitative easing policy announced on Thursday, but from a very different angle from the news reports. But to start with, let’s look at a chart from Japan (click for larger image). Why? Because, demography-wise, Japan has already got to where most will soon be–or rather it is a couple of steps ahead.

Japanese Demographics jpeg

The chart is taken from a wonderful (at least for me) publication from the Japanese Ministry of Finance called “Japanese Public Finance Factsheet“. As you can see, we have two pigs making their way through the python: 6.5 million just retired baby boomers and 7.9 million second baby boomers–the offspring of the original baby boomers.

Next a crash course on the components that make up an interest rate. These include the risk free rate, expected inflation, default risk, liquidity risk and maturity risk (often called the term premium). When you buy debt in a country’s own currency, the default risk is generally minimal (the government can tax or even, ultimately, print more money to pay its debts). Moreover, government bond markets have huge volume, so your liquidity risk (your ability to sell whenever you want) is also not an issue. The maturity, or term, premium is a bit more technical, but its pretty small so I shall put it to one side.

So, simplistically, we can focus on the risk free rate and expected inflation rate when considering government debt (and the interest rates on government debt is the reference point for interest rates on all forms of debt). What’s this got to do with the above chart? A lot, because every introductory text book is based on the axiom that individuals will prefer to consume something now rather than consume it tomorrow. Put another way, the risk free rate is the price an individual (more formally individuals in aggregate) demands to defer consumption. It’s a kind of anti-hedonism bribe.

Now look at the above chart again. What do you think those just-retired baby-boomers are most worried about? I hazard a guess that it is maintaining an adequate level of consumption into old age. Do they need to be bribed? No, they are scared witless that they will be destitute in old age anyway. In particular, Japan’s government debt mountain must produce a visceral fear: the elderly know that their future spending power will be subject to continued assaults from either tax rises (such as consumption tax hikes) and/or cuts to welfare spending. They may not know when these things will happen, but they know they will happen,

How about the second generation baby boomers? While only in their 40s, they see ahead of them a huge phalanx of the elderly that will need to be supported by taxes on them. Moreover, they are working within an economy that has seen meagre growth and falling median real wages. Put bluntly, they are also scared witless about having any spending power in their old age too.

So for these key demographic cohorts in Japan, the real interest rate is likely to be zero. Indeed, I think for many it may be negative; that is, a lot of Japanese would be willing  to handover one million yen now if they were guaranteed to get 900,000  yen of  consumption (in real terms) 10 years down the road. No economics text book sees the world that way, because no economics text book takes into account the never-seen-before demographic patterns of the present day.

What happens if we introduce some inflation? This is what the Bank of Japan Governor Hiroki Kuroda has vowed to do. Indeed, he has undertaken to continue with unconventional monetary policy until 2% inflation is achieved. His aim is to force consumers into buying something now since it will cost much more in the future. And, indeed, this is what happens in the face of consumption tax hikes. However, consumption tax hikes are one-off events, and, after each hike, consumption falls back down to where it starts. So to get consumers to repeatedly bring forward consumption you need to achieve consistent and ongoing inflation.

Now if the economy were merely made up of durable goods, this strategy may work. But what goods and services are the just-retired baby boomers most worried about securing in old age. It certainly isn’t that most durable good of all, housing, they already have that need covered (and if they don’t, it’s too late now). Obviously, the biggest concerns are home care and medical expenses–and you can’t pre-consume these. Similarly, those 40-year old baby boom echoers may wish to upgrade their cars, but they are mindful of the black hole in the Japanese government’s finances–so all spending decisions will be ultra cautious.

Strangely, in the face of rising inflation expectations–and with no investment available that has a return that will match those inflation expectations–a prudent person may logically decide to cut back further on current consumption in order to have any chance of maintaining a dignified standard of living in later life. This means demand will remain flat and for some even fall, and so the expected inflation never actually makes the transition into real inflation. In short, QE does not dig the country out of a deflationary hole.

And so to Europe. From the above chart on Japanese demographics, we can extract an old age dependency ratio; that is, the number of people over 65 divided by the number of people in the working age band of 20-64. For 2014, this was estimated to be 46%, for 2025 it is projected to be 56% and for 2040 is forecast to be a pretty stunning 72% (seven elderly per 10 working age).

For Europe, I’ve constructed the following chart (click for larger image) from Eurostat data (here) concentrating on the Big Three eurozone countries and the so called PIGS (Portugal, Ireland, Greece and Spain). I’ve also thrown in the non-euro UK for good measure.

EU Dependency Ratio jpegThe ratios in Europe are calculated a little differently, since the working age population is defined as 16-64 as opposed to 20-64 for Japan. Accordingly, if you put the Eurostat numbers on a like-for-like basis with the Japanese numbers, they would be a couple of percentage points higher. However, the message is the same: Europe is on the same road as Japan, just a little behind. Moreover, some of the most economically troubled countries, such as Greece and Portugal, are furthest along that road.

My bottom line: the EU’s new monetary policy, which aims to slay deflation by dragging consumption forward, may prove as ineffective as it has in Japan. Very sensibly, many households don’t want to consumer now, because they fear they won’t be able to consumer later, in old age.

I also think these dependency charts raise some deeper questions over the nature of consumption, growth and happiness itself. Most studies of happiness show the over 60s scoring highly. Their need for so called positional goods using the sociology definition (goods that confer status) appears more muted. The advertising industry thrives on the idea that happiness is derived from both what we consume now relative to others and what we consume now relative to what we consumed in the past.

In an aged society, such constructs of happiness appear less relevant. Indeed, if the elderly can detach happiness from rising income, consumption and, by extension, economic growth, why can’t everyone? Unfortunately,the monetary authorities of both Japan and the EU don’t appear able to recognise this fact.