21 December 2009


by Andrew McKillop
Former chief policy analyst, Division A Policy, DG XVII Energy, European Commission
December 18, 2009

Depreciating Global Warming and Appreciating Real Assets

"Hockey sticks in the air!" well summarises the Climate summit debacle and face-saving attempts by Europe's hardcore political defenders of "imminent climate catastrophe" to breathe more hot air and illusion into the Copenhagen chill, as the COP15 conference winds down and out. The attempt by Europe's climate conscious leaderships to surf the wave of public concern on so-called runaway global warming, and generate new export markets for the continent's overlevered, high output cost renewable energy corporations and companies with recession hit domestic markets, looks unlikely to succeed. The same applies to Obama, faced by a recalcitrant Congress with low conviction that now is exactly the right moment to launch an additional big government, big spending spree with borrowed public money - much of it overseas, on projects outside the USA.

One sure winner will be real resources. That is oil, natural gas, gold, some other metals and minerals, and many of the agrocommodities. The linkage is clear and easy for oil, and for natural gas: the big spending push in renewable energy (RE) is now delayed, although already proven and economically viable RE will continue to power ahead. Fast uptake of RE in the lower income countries - which would only be possible with major aid and big soft loans from richer nations - will now take a lot more time.

Both China and India will continue their own, already large RE and Cleantech development programs, but this will have little spillover to the lower income developing countries in the near term. Along with rising but confused signs of economic recovery in the US if not in Europe or Japan, and continued strong economic growth in the big Emerging Economies, the bottom line for world oil demand is clear. Demand is likely to pick up through Q1 2010. Traders will anticipate this in a trading context marked by a return to selling pressure on the dollar (presently upstaged by a falling Euro),signaling higher oil prices from the short term. To be sure, events such as the December 22 OPEC meeting will generate their own price moves, but the new fundamental for oil is that global demand is likely to grow.

Unlike the recent past, natural gas futures will also tend to rise in synch with oil, rather than falling anytime Brent and WTI rise, and rising anytime Brent and WTI fall. Gas is the clear winner from attempts at finding cheaper, lower carbon substitutes to oil, but its price has languished this year. With restored oil price growth, natural gas will this time also gain.

The J-Curve

Exactly like the global warming Hockey Stick, but real, delayed response to converging news in the trading rooms operates a J-curve for short-term prices. While traders are out to lunch and deciding how to react, their first action will be trimming positions and paring risk before they go out to a sushi meal of near-extinct red tuna. Like the impact of dollar devaluation on the monthly US trade deficit, the first impact is a deepened deficit. For traded real resources, increased and complex news that should generate price rises firstly generates lower day closing prices.

The complex news from the Copenhagen climate summit through its long, laborious and heated sessions is that this "qualified success" will do less than nothing to rapidly trim fossil energy demand in the emerging and developing countries, and probably little in the OECD group of rich nations with one-sixth of the world's population but consuming one-half of world oil production. In the OECD group and especially Europe, however, climate change business has become Too big to fail which for energy will generate higher prices across the energy space. Returning from lunch, the signs for traders will be clear that real resources are better placed to show asset growth than most mainline Equities on many markets, of course with ample exceptions, and for as long the global economy shows credible signs of coming out of recession.

This is far from radical as a near-term read out, and is reinforced by another J-curve, the reserve/production ratios which apply to an increasing swath of the real resources, aka the hard assets.

We can state this simply: Gold, copper or any other diminishing fossil or mineral asset, including the fossil fuels is still faced with relatively price inelastic, and recovering or increasing demand. Exactly as for per capita oil and gas consumption in the OECD countries relative to China and India, and therefore CO2 emissions per capita, the same stepwise difference in consumption applies to metals and minerals. Increasing world production to enable equalization of per capita demand is, to be sure, a theoretical target for global economic development, but is not possible.

Obligation to Perform

The obligation to perform overrides the almost philosophical question of deciding if the party will continue, or rather when the party's rules will change, which they will but not at Copenhagen. Easily explaining why China and India will in no way agree to global binding commitments reduce CO2 emissions, but will act to slow their increase, this simply conforms with long term trends of economising resource utilisation, recycling and substitution rarer and higher cost resources with more abundant and cheaper resources. This is a long-term factor in human history and the world economy.

Break points are however certain in a free-for-all where each player is unsure of the resources held by the rivals, each player has an obligation to perform, and many natural resources are becoming rare. As many examples show, late arrivers are not at all necessarily the losers, witness Angola or Canada for oil, Kazakhstan for uranium, Zimbabwe for platinum, and the present and future bioresource and renewable fuels exporters of Africa and Asia. Depending on technology change and metal, mineral, or fossil energy substitution potentials, this now-or-later choice will increasingly impact day traded and near-term commodity prices as global potentials for radical output hikes increasingly shrink.

Rising real asset prices have an interesting self-limiting production impact, running alongside physical depletion and rising environmental impacts from their extraction and production. When their daily market price rises, the future value of presently unexploited reserves increases, and forecast production needed for a given revenue (of course in devaluing paper money) decreases. For gold and other PMG metals there is a measurable and predictable impact of rising prices on physical output capacity, basically due to milling capacity, with easily made comparisons in other fossil extraction industries. For gold and the PMG metals, when prices rise, and if a producer moves to lower grade ores they will for some while operate the same milling capacity. Due to this, total output will fall with rising prices, not rise.

This is a stealthwise change of physical output capacities, finally impacting the obligation to produce, and aiding the policy shift to a preference for slower exploitation of depletable resources. This shift is in fact nothing more or less than an update of the old-time wisdom of gold miners. This was a simple one-liner: Worst grade first, best grade last.

Despite the fact that other considerations also count, this one-liner is hard to beat. Ecology minded economists going as far back as Georgescu-Roegen and Daly, and in fact even further back can echo this wisdom, with multiple caveats, drawing on ecosystem behavior and functions. More than 90% of the trophic hierarchy acts this way, allowing just a few breakthrough and emergent alpha male species to act otherwise. To be sure there is one really large difference: natural ecosystems are close to 99% based on renewable energy, but the global economy is around 84% based on non renewable fossil fuels, and 100% dependent on non renewable metals and minerals including uranium, phosphates and all other one-shot, only partly recyclable resources.

Obligation to Deplete

Only one remedy applies to maximising output of non renewable resources that start depleting and fading away: energy. When or rather if there was 'unlimited energy' we could imagine all manner of science fiction, and economic fiction futures. In the real world and in all history, we have neither the time nor energy for this.

The above theoretical aside can be terminated by looking at the way major gold mining, fossil energy and minerals producer companies have cozied up to host governments, and through a long period of about 1985-2005 chose suicidal producing strategies. Accelerated depletion is surely one large, but hidden real world driver of the loud public statements that we face "climate catastrophe" if national budget deficits are not further raised, this time to finance Green Energy rather than bail out near-bankrupt finance sector players. Fighting depletion of energy and other real resources is the scarcely hidden message of OECD leaders, which failed at Copenhagen.

Brave words are advanced on the theme that accelerated depletion of fossil energy will 'jumpstart' innovation in alternate energy, and speed the 'modernization' of the economy. For the non renewable resource of gold, this innovation in fact has a long pedigree. Taking gold as a fiduciary money base, it can be substituted by silver, then bronze, then iron, and why not aluminium, paper, plastic and most recently electrons ?

Debate on whether we can sustainably extract oil from tarsands , or copper and other metals from sea water is basically a question of energy. This is due to energy needs spiraling as leaner and leaner orebodies and resources are exploited. Stepping down in orebody richness does not generate a linear increase in energy needed to extract the same amount of metal, but much much more, determined by many convergent factors we can call 'entropic'. This stepwise increase in energy demand is only partly covered by technology progress - and is a major physical determinant of rising prices for current generation resources, and a marker for the certainly rising capital costs of future energy and minerals supplies.

The 'Climate Catastrophe'

The re-valorisation of gold and other real assets is taking place at a time of surreal change in economic policies and policy making, symbolised by the strident calls for a massive and massively rapid shift away from fossil fuels, to the renewable energy sources and systems. Failure of the Copenhagen farce, however, will surely reawaken media and public opinion to the real, and very complex trends of both natural and anthropogenic climate change, along with anthropogenic ecosystem disruption, degradation, and destruction. In the same list, ongoing and rising pressure on natural resource supply capacities for constantly growing human population numbers and even faster growing urban populations will exercise a constant impact.

Extreme flights of fancy of the world's deciders, hinged on global warming, are likely to be put on the back burner, for example attempts to save the US dollar, through proposals to replace it as the world reserve money, with a "CO2 Bancor". This new plaything for FX traders and central bankers could be cobbled together from a shifting pile of carbon finance instruments, CO2 offset bonds for 'soft energy' loans to developing countries, carbon tax revenues and their derivatives, and other creative paper promises of future value built on the shaky struggle to fight climate catastrophe. This will signal a return to normal business, in a context where both Equities and Commodities are now completely interdependent and interchangeable trading chips - for traders and financial market operators.

This changes nothing on the ground, or rather underground. Long-term trends to more sustainable resource development - meaning long term production strategies - will be accelerated in a context of higher energy prices. For gold mining this is already clear: companies who want to remain in business for more than a few decades have already started to shift back to mining at the marginal grade. This raises production costs, and caps output, moving the threshold up for future price corrections on exuberant and always exaggerated trading floors.

Higher commodity prices effectively cause the marginal grade of every gold mine to drop. In the energy space this shift will be intense, as the world shifts to lower intensity, harder to use and higher capital cost renewable energy which can only increase slowly, after big capital expenditure. The net result is simple to forecast: as for gold output which has shown little or no responses to a tripling of the dollar price since 2002, world energy supply is set in a relatively slow growth, or no growth outlook, we can summarise as net energy and natural resource output falling as prices rise and because prices rise.

© 2009 Andrew McKillop


Climate deal 'good but not perfect', says Flannery

Copenhagen Climate Council chairman Tim Flannery says a draft climate accord reached by world leaders is ‘‘good but not perfect’’, and has described Prime Minister Kevin Rudd’s role at the summit as ‘‘outstanding’’.

Speaking in an online briefing from Copenhagen shortly after 11pm local time (9am AEDT), while final details of the draft accord were still to be announced, Professor Flannery said the science community believed the draft text was a few hundred gigatonnes short of ideal, but that he was ‘‘not entirely dissatisfied with the agreement’’.

Wealthy and key developing nations have agreed to limit global warming to two degrees Celsius, according to a US official, with each country required to list the actions they would take to cut global warming pollution by specific amounts.

‘‘We need a more aggressive reduction target by the US ... (we need) China to tighten up its emissions standards,’’ Professor Flannery said.

This, combined with a concrete agreement among European countries, he said, would ‘‘put us in a better position ... where we need to be’’.

But he said the talks in the Danish capital were ‘‘not the end of the story’’.

‘‘We’ve seen a huge advance at this meeting ... This is a step on a long road and I’m not entirely dissatisfied with the agreement.’’

The draft text was ‘‘good but not perfect’’, he said.

Professor Flannery said he was impressed by the direct and honest role played by Mr Rudd at the summit.

‘‘Our prime minister has played an outstanding role. I was at a briefing he gave on Thursday. He was frank and honest ...
He said he was doing his best but there was absolutely no guarantee of success.

‘‘He’s been working very hard the last few months,’’ he added.


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