Streetwise Professor

September 3, 2023

Shell Has a Come to Jesus Moment: Will the Politicians? Alas, Probably Not.

Filed under: Climate Change,Commodities,Economics,Energy,Politics,Regulation — cpirrong @ 3:22 pm

In 2010, along with my UH colleagues Victor Flatt and Praveen Kumar, I taught what I believe was the first academic carbon trading course in the world. My lectures in the course related to the economic challenges of creating traded commodities, specifically the challenges of merely defining what the commodity is and monitoring adherence to the standards so established.

Now, this may seem trivial, but even something like “wheat” poses challenges due to heterogeneity related to quality (even within a given variety, such as soft red winter wheat) and monitoring whether the wheat traded under a contract adhered to the relevant terms agreed to by the parties. Indeed, as I noted in an early article of mine, the genesis and early development of commodity exchanges like the Chicago Board of Trade and the Liverpool Cotton Exchange was not driven by the desire to trade futures: these were cooperative, private efforts to define property rights and to create a mechanism to standardize commodities and to adjudicate contractual disputes primarily over quality. Only after these challenges were met was it possible to trade futures. Standards (and their enforcement) are obviously a necessary condition for trading standardized instruments like futures.

The major intended takeaway from my lectures in 2010-11 was that the problems of standard definition and especially standard enforcement were even more daunting in carbon than in traditional commodities like wheat or cotton, and that this was especially true with respect to carbon offsets–things like contracts to plant trees to capture carbon.

How do you define what is being bought and sold? How do you monitor whether the offset contracted for performs as agreed? How do you address contract performance failures? The Chicago Board of Trade struggled for years to overcome these issues in wheat and corn and oats in the post-Civil War era, even though the trade was relatively geographically concentrated, the contracts were of relatively short duration (typically for a single consignment), and the commodity was relatively simple.

All of these challenges are far greater for carbon, let alone for offsets. Sources of carbon emissions are numerous and diffuse and costly to monitor. With respect to offsets, they are highly heterogeneous; have very long lives; require continuous investment and upkeep; and have highly unpredictable performance (e.g., the forest that you plant may burn down, or be ravaged by insects). These contracts are far more complex than a deal to buy 10,000 bushels of SRW winter wheat for delivery in Chicago next month. Moreover, many offsets are located in countries with weak–and sometimes close to non-existent–legal systems.

Furthermore, the incentives of the parties to these agreements can be perverse, especially for “voluntary” offsets. A buyer who pumps its ESG score by purchasing offsets that turn out not to perform seldom suffers serious adverse consequences (although there is some backlash against “greenwashing”), and the seller has a strong incentive to collect the cash and not make the necessary expenditures to ensure that the offset performs as promised.

I taught the class in the immediate aftermath of the Global Financial Crisis, and I suggested that there were a lot of similarities between offsets and the kinds of deals that wreaked havoc in the banking system in 2008-2009, where bankers paid their bonuses upfront based on imagined profits predicted by highly speculative models to be realized over several years churned out garbage securities.

In 2010 I was therefore extremely skeptical about the viability of markets for offsets. And the defects that I talked about have been increasingly recognized in the last year or so.

I believe that the actions of Shell during the last week represent an authoritative recognition that these predictable–and predicted–problems have come to pass. Like other (especially European) energy firms. Shell made ambitious carbon reduction pledges that it intended to meet largely through the use of offsets. But reality has reared its ugly head, and Shell is all but abandoning this strategy. Other companies (e.g., Microsoft) say that they are still committed, but if they are even remotely interested in spending their shareholders’ money wisely, they will eventually have the same come to Jesus moment as Shell.

A Shell-funded mangrove restoration project in Senegal (Bloomberg).

This represents another grievous blow to the ambitions of the Net Zero fanatics. Offsets are a major component of Net Zero plans. Renewables are another part–and reality is catching up with that too (as the travails of Danish renewables developer Orsted and German turbine manufacturer Siemens demonstrate).

But will the fanatics be deterred? Alas, it appears not. Indeed, they appear to be doubling down, as illustrated by lunatics like Michael Gove:

Net Zero and the policies intended to bring it about–including extensive reliance on renewables and offsets–are a guaranteed recipe for an impoverished future. This was predictable–and predicted–more than a decade ago. But when will the madness end? I am guessing not before these policies cause economic catastrophe.

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  1. Gove is an odd one. Clever, a bit bonkers, infinitely ambitious, and deeply untrustworthy. I find it hard to think of any circumstances where I could bring myself to vote for him.

    Anyway, Shell: at one point I consulted for them on the subject of “stranded” gas deposits. Once I’d absorbed the fact that they were advocates of trading Indulgences my enthusiasm cooled. The company was packed with engineers and scientists who understood thermodynamics and yet they all paid lip service to this rubbish. Sad.

    Comment by dearieme — September 3, 2023 @ 6:03 pm

  2. Like the Conservatives generally since Cameron, Gove is not a Conservative at all. The Conservative party has been thoroughly penetrated by entryists from the Green and Liberal Democrat parties, so what we have is a Green / Liberal Democrat government that is, like the Holy Roman Empire, neither green nor liberal not democratic. If you look at the way they voted during the Brexit contortions, and at what they are doing to force wind turbines onshore, it is clear that the typical Conservative MP is a constructive Liberal Democrat.

    Gove is one of the worst of the lot; in fact, his assaults on property rights suggest that he is actually a full-blown authoritarian Marxist. We can be quite sure that once he has finished destroying the rental property market, he will turn to owner-occupied property next.

    For my money, the reason the supposedly rightist Conservative Party became the target for the hard left to infiltrate and take over is that they despair of the more obvious target, the Labour Party, ever gaining power. It’s astonishing that this has been so successful, but perhaps explained by the fact that ideologically speaking the Conservative Party has been an empty suit since November 1989.

    Comment by Green As Grass — September 4, 2023 @ 4:03 am

  3. Prof, I’m afraid that you were “scooped” by the cartoon King of the Hill (Season 13 Episode 2) in identifying that offset companies have little incentive to ensure performance, that buyers have little incentive to investigate too closely and that consumers are easily swayed by the carbon offset marketing. Though they didn’t quantify anything mathematically, so I guess you aren’t at risk of unemployment 😛

    But seriously, I think you’d enjoy that episode and how they were lampooning (back in 2008) all those points you raised.

    Comment by HibernoFrog — September 4, 2023 @ 8:04 am

  4. ‘But when will the madness end?’


    Comment by Ex-Global Super-Regulator on Lunch Break — September 5, 2023 @ 6:05 am

  5. All hail to the spivs!
    If Shell are so spineless as not to be able to stand up for their industry – under attack by a retarded schoolgirl and the slivey Gove – then they deserve to be taken to the cleaners by all the shysters in the Western hemisphere.

    Comment by philip — September 5, 2023 @ 10:08 am

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