The red-hot housing market is a topic of cocktail conversations, at least among those comfortable to take that step back to normalcy. The S&P/Case-Shiller U.S. National Home Price Index (C-S) sports a 14.6% year-on-year increase through April. Residential real estate benefits from numerous sources of government support. Property taxes are tax-deductible up to $10K (although in NY and NJ the benefit is derisory because taxes can be 2-3% of a home’s value). Mortgage interest is also tax deductible, and the Federal government underwrites the credit risk of conforming mortgages which lowers their interest rate. Add to that the $40BN in monthly MBS purchases, part of the $120BN in long term bonds the Fed is buying which acts to further depress rates. So on top of the various tax subsidies and guarantees, the Federal government is lending almost half a trillion dollars a year to home buyers. It’s no wonder home prices are rising.

The Fed measures housing inflation by relying on a survey by the Bureau of Labor Statistics on what monthly rent homeowners think their home could command if rented. It’s safe to say that Owners Equivalent Rent (OER) is not the subject of the abovementioned excited cocktail chatter because it’s a theoretical concept – the only element of the inflation statistics not derived from actual transactions. Its weaknesses are well documented and we won’t belabor them here (for more detail, see Why You Can’t Trust Reported Inflation Numbers). Suffice it to say that OER doesn’t reflect the cost of housing for the two thirds of households who choose to own their home. The S&P/Case-Shiller U.S. National Home Price Index has risen at an annual rate of 4.4% over the past two decades, versus 2.6% for OER. The Fed’s use of OER means it has persistently ignored inflation in the biggest expense households face.

Although the FOMC is more in thrall to progressives than bond vigilantes nowadays, their full-on spiking of the punch bowl is making some increasingly uneasy. Boston Federal Reserve Bank president Eric Rosengren is worried that a housing “boom and bust cycle” will threaten financial stability. It’s hard to find any serious support for the Fed’s continued buying of MBS in the financial community. Even the liberal wing of the Democrat party must conclude that few beneficiaries of housing inflation are likely to be found among their core supporters.

The continued strong housing market speaks to the imminent conclusion of at least this element of the Fed’s $120BN monthly bond buying. Expect the FOMC to curtail it during the third quarter, as a growing chorus of economists and investors warns of another housing bubble. Eurodollar futures priced in earlier monetary tightening following Powell’s press conference a couple of weeks ago, so that the yield curve now more closely resembles the forecasts from St. Louis Fed president James Bullard than Jay Powell (see The Fed, Thinking Fast Or Slow). But there’s still more downside price risk than upside for futures.

Switching to energy markets, those of us outside California will appreciate this priceless headline:  California Asks Residents to Avoid Charging Electric Cars Amid Power Grid Strain. The Golden state is pursuing altruistic energy policies – swearing off everything but solar and wind, yet unable to provide reliable power. One problem is they’re ahead of most of the world in shifting as quickly as possible to largely renewable power (2018 was 34%). Global greenhouse gas emissions continue to rise, mostly due to rising living standards and energy consumption in developing countries. To the extent that climate change is responsible for the heatwave across western states, Californians are enduring both the results of global warming and the costs of mitigation without any visible benefit.

Of course renewables aren’t directly responsible for California’s power shortages, although had they redirected solar and wind investments to modernizing their existing grid and boosting conventional power sources they’d be in a better place.

The energy transition is a multi-generational marathon. It’s not an endeavor that lends itself to a declaration of victory, although defeat will be recognizable. This will be a problem for politicians, but it’ll be interesting to see how enduring popular support is to phase out fossil fuels in California and elsewhere. The effort will need to last decades while the connection with changing weather will remain tenuous. Few other states will see much to emulate in their approach.

We are invested in all the components of the American Energy Independence Index via the ETF that seeks to track its performance.

Recently Pembina and TC Energy announced a joint venture for Carbon Capture and Sequestration (CCS), aimed at CO2 emissions generated from Canada’s tar sands oil extraction activities. Canada has an ambivalent stance on climate change policies. Like all signatories to the Paris Accord, they claim to have set aggressive targets for emissions reductions. Canada also has a carbon tax, a sensible measure to place a price on emissions that has little support in the US.

But Canadians also have one of the highest per capita rates of energy consumption in the world – almost a third higher than Americans, who are often regarded as the world’s energy gluttons. A Canadian’s emissions are about the same as an American’s, because of their greater access to hydropower. But Canada’s emissions have been stable, not falling as in the US where coal to natural gas switching has been the main source of reductions in the past decade. 2020 emissions fell everywhere because of lockdowns, but are rebounding.

Part of Canada’s struggle with emissions is a result of its long winters. But tar sands oil production is another. This is an energy-intensive process that involves heating bitumen with natural gas to separate out the crude oil. It’s fair to say that Albertan energy workers are less concerned about climate change than their liberal neighbors in Ontario and Quebec, even though western Canada supplies eastern provinces and generates substantial tax revenues.

Images of tar sands production facilities were sufficiently emotive to sustain extremist opposition to the proposed Keystone XL pipeline for a decade, until Biden finally killed it off last month.

Canada will continue to produce oil from tar sands, even though transportation to market has become a chronic problem. Its crude will move by rail, instead of cheaper and safer pipelines. But the Canadians recognize they have an image problem, hence the recent announcement on carbon capture.

The Alberta Carbon Grid (ACG) will initially capture CO2 generated from the extraction of crude from tar sands. But there are also plans to connect with areas of industry elsewhere in the province and to power plants as well. It will use existing oil pipelines that will be retrofitted to transport CO2, and will add new infrastructure on to it.

Estimates are that the initial system will capture and sequester underground 60-80,000 metric tonnes (hereafter “tons”) of CO2 daily. One advantage of Canada’s cool climate is that it’s easier to inject the CO2 underground into porous rock when daytime summer highs are typically in the 60s. The JV has identified an underground reservoir near Saskatchewan with capacity to eventually store over 2 Gigatons of CO2, which will take several decades to fill.

The projected annual volumes equate to around 4% of Canada’s total 2019 CO2 emissions of 730 tons, which seems quite impressive for a single project. By contrast, Exxon Mobil’s planned CCS in Texas is projected to sequester 50 million tons annually beneath the Gulf of Mexico. This is 60% bigger than the ACG but less than 1% of US 2019 emissions.

CCS is drawing more attention. Its appeal to the fossil fuel industry is that it offers a way to continue today’s energy mix while reducing emissions. Climate extremists oppose such thinking because they’re passionate about a world of solar panels and windmills. But when you work through the math, the cost of capturing all the CO2 emitted from the combustion of natural gas is not an insurmountable figure. Its implementation is also much more plausible than carpeting the landscape with intermittent renewables along with the extensive high voltage power lines required to move it from rural areas to population centers. Massachusetts can’t even buy hydro-electric power from Quebec because New Hampshire won’t allow the necessary power lines to be built in their state.

The tax code already pays a $50 per ton credit for permanently sequestered CO2. The Clean Air Task force thinks it should be higher, and has estimated the cost of capturing CO2 from different sources – ranging from as little as $39 per ton for CO2 produced in gas processing to $100 per ton in cement production. Industrial emissions with more concentrated CO2 allow for cheaper separation of the CO2.

The table shows that even at a substantially higher cost of $150 per ton, the CO2 emitted from burning natural gas could be captured with an increase in our overall energy spend of less than 20%. A new CCS industry would create jobs just as the president promises ramping up renewables would. Anyone truly worried about global warming and not simply proselytizing for renewables would surely embrace this as worth the cost.

The energy transition is about economics, not technology. The solutions are mostly known. Costs can be reduced through scale and innovation continues, but it’s about society’s willingness to pay for the cost. The point of the table is not to try and persuade climate extremists, but to show that substantial emissions reductions are possible without our power supply failing us when most needed, as in California for example.

Today’s energy companies have a lot riding on the outcome, which is why CCS is gaining more attention. As their solutions become more visible, the sector will continue its recovery.

We are invested in all the components of the American Energy Independence Index via the ETF that seeks to track its performance.

This is an assertion made by economist Roger Bootle. Two decades ago he argued the opposite, in The Death of Inflation: Surviving and Thriving in the Zero Era. But now the founder of Capital Economics regards, “the environmental emphasis and in particular the drive towards net-zero” as the single biggest factor pushing inflation higher.

The Administration’s ready embrace of deficit spending to finance a laundry list of progressive Democrat priorities is one source of inflation. Negotiations with Congressional Republicans over an infrastructure plan appear to be stalling, which will result in another enormous round of spending approved by reconciliation so as to avoid a Senate filibuster.

Stephanie Kelton gave us the fiscal policy blueprint in The Deficit Myth (see our review here). Because the government can’t default in its own currency, any amount of spending is good until it’s inflationary. The corollary is that spending to fix everything is inadequate until it’s inflationary. This includes financing the energy transition. Democrats have embraced her ethos with enthusiasm.

In a narrow sense, inflation can be defined as price increases in excess of the utility provided. When workers received a 5% pay increase with no change in output per worker (i.e. Improved productivity), that became the 1970s definition of inflation in Britain’s union-ravaged economy. It seems straightforward when applied to labor, but prices of all kinds of goods and services rise without causing an inflationary spiral. College tuition and healthcare defy gravity, but in the past year commodity inflation has become widespread too.

Copper is an example. Goldman Sachs estimates that an electric vehicle requires five times as much copper wiring as an internal combustion engine, and a 3-megawatt wind turbine (enough to power around 800 homes) uses up to 4.7 tonnes of the metal. Electrification of everything is central to the energy transition, which has pushed copper prices to the highest in a decade. Oddly, this isn’t yet stimulating increased investment in new production, which on current trends will drop by half over the next five years.

For different reasons, crude oil prices are rising – here, the rebound from Covid is colliding with reticence among the large publicly owned energy companies to invest in new production. Because the average oil well’s output falls at 3-5% per annum through decreasing pressure, that much new output is needed annually just to maintain supply. Exxon Mobil, Chevron and Royal Dutch Shell are all likely to spend less than previously planned, which is improving market fundamentals for those unburdened with climate extremists as owners, such as OPEC and Russia (see Profiting From The Efforts Of Climate Extremists).

Although the media breathlessly forecasts imminent peak oil, demand continues to grow. The world is likely to return to its pre-Covid 100 million barrels per day level by year’s end.

The increases in copper and oil are both inflationary, even though they’re the result of opposing energy transition effects.

Inflation is rising and concern is widespread. The Fed is enabler-in-chief. They’re actively seeking higher inflation while brushing away any evidence it’s rising. Commodities are tight because of logistical issues that will be resolved; energy is volatile and should be ignored; housing inflation is measured by the quixotic approach of surveying homeowners on what they could rent their house for – a truly dumb construct unmoored from reality (see The Fed’s Narrowing Definition Of Inflation). Only an economist could love it.

Criticism is growing, including from former Federal governors. Kevin Warsh warned about The Fed’s Risky Fill-the-Punch-Bowl Strategy. Warsh notes that the Fed has bought 56% of the government debt issued since the pandemic began. They don’t even need Stephanie Kelton on the FOMC — her philosophy is already mainstream. Warsh says the Fed, “… should stop buying mortgage securities immediately. Soon after, it should slow its purchases of Treasury debt. It should not tolerate Fed-financed fiscal expansion.”

Bill Dudley, NY Fed president 2009-18, says, The Fed Is Risking a Full-Blown Recession in a recent Op-Ed. He argues that the Fed’s three criteria for raising short term rates (employment has reached its maximum sustainable level, inflation has reached 2%, and inflation is expected to remain above 2% for some time) mean they’ll be late. Dudley bluntly warned markets have underpriced the likely path of short term rates, a stinging rebuke from a former FOMC member.

The energy transition will increase prices. Where renewables are a bigger source of electricity, it’s either more expensive (Germany), prone to weather-induced disruption (Texas) or both (California). It shouldn’t need pointing out, but if renewables were cheaper than gas and coal they’d be ubiquitous and China wouldn’t be building new coal plants equal to current U.S. coal-burning capacity. Vaclav Smil, prolific author of many thoughtful books on energy and related topics, estimates that a new combined cycle gas turbine will still be 75% cheaper over its life than solar or wind (see the chapter Why Gas Turbines Are The Best Choice in his new book Numbers Don’t Lie).

Blackrock’s Larry Fink said, “If our solution is entirely just to get a green world, we’re going to have much higher inflation, because we do not have the technology to do all this, yet.” He continued, “That’s going to be a big policy issue going forward too: Are we going to be willing to accept more inflation if inflation is to accelerate our green footprint?”

The energy transition is likely to be inflationary because energy will cost more. To some degree this might be a price worth paying for sensible climate risk management, although climate extremists are purists with no regard for cost-benefit analysis. Smil’s figures suggest a full-blown rush to zero emissions might cause prices to quadruple or more. Since energy prices affect everything, the consequences will be broadly felt.

Because the Fed is monetizing a good portion of the debt used to finance government spending, this has the potential to magnify the inflationary impact of higher prices.

It’s no surprise that inflation is the topic most often raised in discussions with investors. Midstream energy infrastructure offers a potential source of protection.

We are invested in all the components of the American Energy Independence Index via the ETF that seeks to track its performance.

 

Do scientists spin the truth in order to explain complex answers simply? That is the suggestion scientist Steven Koonin makes in his new book Unsettled: What Climate Science Tells Us, What It Doesn’t, and Why It Matters.  

Koonin speaks with some authority – his career includes being BP’s chief scientist 2004-09 followed by serving in the Obama administration as Under Secretary for Science 2009-11. He has a PhD from MIT in Theoretical Physics. Koonin applies his scientific background to the complex area of climate change.  

Koonin is no climate denier. He readily acknowledges that human activity is increasing CO2 emissions, warming the planet. From there, he walks the reader through two huge uncertainties – how much global warming have we caused, and how bad will it be anyway.  

The UN’s Intergovernmental Panel on Climate Change (IPCC) has issued a series of reports which led to the 2015 Paris agreement, where countries agreed that limiting global warming to 1.5 degrees Celsius above pre-industrial levels was necessary to avoid irreversible damage to the planet. Humanity’s future hinges on this binary outcome. 

In a world of soundbites, “The Paris Accord”, “Zero by 2050” and “Saving the Planet” have all become shorthand rallying cries galvanizing action by governments, corporations and investors worldwide. The implication of certainty grates with Koonin’s scientific mind which accepts degrees of uncertainty around virtually any forecast. Using computers to model the climate (as distinct from weather) taxes the powers of even today’s supercomputers.  

Global warming is likely to raise sea levels – but it turns out this has been the case since at least 1900, long before human use of fossil fuels drove CO2 levels higher. While it’s true that the 3mm rate of annual increase over the past twenty years is higher than over the past 100, the 1930s saw a similar rate.  

The media often blames extreme weather events on climate change – we’re better at measuring hurricanes, which before satellites were only recorded where they encountered people on land or at sea (assuming they survived). Nonetheless, it’s hard to see any link between the fluctuations in hurricanes and rising CO2 levels.  

None of this is intended to eliminate the likelihood that we’re warming the planet – simply to demonstrate that the consequences are hard to isolate.  

Moreover, Koonin notes that weather-related catastrophes are killing fewer people, drawing on research from Bjorn Lomborg’s book False Alarm; How Climate Change Panic Costs Us trillions, Hurts the Poor, and Fails to Fix the Planet.  

Food production, which we’re warned will collapse with warmer temperatures, has risen with a warmer planet.

The UN reported record world cereal production last year. Inconveniently, rising CO2 levels are improving plant growth. The UN cites a report that satellites show a marked increase in leaf coverage for 25-50% of vegetated areas.  

The U.S. Global Change Research Program (USGCRP) is a Federal agency charged with assessing the impact of climate change. Their Fourth National Climate Assessment was published in 2018, and is full of warnings. But the economic consequences, as Koonin notes, seem insignificant.  

The Assessment estimates the economic cost of different scenarios. Although the chart  extends as far as a 15° F temperature increase by 2100, most serious forecasts of inaction are in the 3-5° range. Assuming 2% real GDP growth, the U.S. economy will grow from $21TN to $102TN by the end of the century. If climate change makes it 2% smaller (i.e. $100TN), that would mean annual growth was 1.97% instead of 2%. The chart looks dramatic, but the plausible economic cost seems inconsequential.  

This really gets to Koonin’s point, which combines uncertain climate forecasts with unclear consequences to ask why there isn’t any cost-benefit analysis done on the world’s response to rising CO2. Bjorn Lomberg and Alex Epstein (the latter in The Moral Case for Fossil Fuels) make similar arguments. Increased energy use has improved living standards for billions of people. Koonin notes that the World Health Organization has said that indoor cooking with wood and animal waste is the most serious environmental problem in the world, affecting up to three billion people. This will not be solved with solar panels and windmills in rural areas of emerging countries.  

The science is uncertain, and the range of possible outcomes includes some very dire ones too. Prudent risk management of the only planet we have demands some steps towards mitigation. Perhaps some of the scientists who do this work, despairing of the difficulty in communicating complex uncertainty, have resorted to simplifying the message in order to promote changed behavior they sincerely believe is needed.  

 Koonin explores this. In the USGCRP’s Fourth Assessment, they include a dramatic chart that shows more record daily high temperatures. This is why hot days cause the media, and our friends, to blame global warming. But the construction of the chart is odd. It takes the number of new record highs divided by the number of new record lows and plots this ratio. Koonin shows that what’s actually happened is that the average coolest temperature has increased, while the average hottest is about the same as in 1900. Our nights have been getting less cold – our days are not warming. The climate is getting milder.  

The chart begins in 1930, so you’d expect a lot of record highs and lows at the beginning of the sample period. This will keep the ratio of the two close to 1.0. As decades pass, the growing prior history will make new records less common, which will also cause the ratio of new highs to new lows to fluctuate more.  

Fewer record cold days with unchanged record highs has caused the ratio of the two to rise sharply. But why display the information in this way? Taking the ratio of new highs to new lows from a fixed date in the past is not at all intuitive, and it portrays a very different picture of temperatures than the actual data. At best it’s an example of sloppy work, and at worst it’s an effort to present a biased picture so as to prompt more urgent action.  

Because political discourse requires you to be for or against, critics call Koonin a climate denier, That is to ignore his thoughtful embrace of scientific uncertainty, and his advocacy for informed choices that try and balance cost/benefit. Too few climate extremists read the science, and if they truly believed humanity’s existence was threatened they’d quickly embrace natural gas power generation so as to phase out coal, and far greater use of nuclear energy.  

The obsession with solar panels and windmills belies lack of serious thought and is why global emissions keep rising – most people care until the energy transition costs them money, which it most assuredly will or we’d have already transitioned. Steven Koonin’s book is a welcome contribution to more informed debate about climate change.  

We are invested in all the components of the American Energy Independence Index via the ETF that seeks to track its performance.