The Drum Opinion (Australian Broadcasting Corporation)
24 June 2011
Chris Andrew and John CrawfordHuman consumption has reached the point where there is no part of the Earth system where our impact cannot be felt.
We are now essentially managing a "global commons" in the sense used in the controversial paper by Garrett Hardin in 1968. In other words nationally-driven trends in consumption of commodities that are essential to life, such as energy, food and water, are so clearly beyond the global capacity to provide that unless levels of international cooperation change dramatically in the next 20 years, we are heading for unprecedented levels of suffering. Many analysts agree that the latter is inevitable.
It is hard to understand why we are not doing more to head off this predictable disaster. Or maybe it isn't. Humanity has had an uncanny capacity to innovate its way around crises in the past. When things start to run out, prices increase and create new market incentives to innovate, thus moving our dependencies away from scarce commodities or reducing demand. This creates an illusion, referred to by Adam Smith as the "invisible hand" of the market, that economies are guided towards optimal outcomes. In other words, we are not doing more to avert disaster because we assume everything will sort itself out on its own. This is obviously true if global markets are rational, but unfortunately markets have never been rational. Furthermore, the complexity and level of sophistication in global markets has reached a point where internal feedback may be driving the system towards increasing levels of instability. These instabilities, such as the current financial meltdown, mitigate against investment in the kinds of innovation that are required to see us through the next 20 years.
The global challenges that we face are extraordinarily difficult because they interact with one another. The security of food, water and energy in particular are all highly interrelated through, for example, biofuel production, rising costs of fertilisers, and the fact that 70 per cent of the fresh water we use is in food production. This means we are not in a position of being able to solve one problem at a time. We have to solve most of them simultaneously.
Finding a solution where there are multiple simultaneous goals (food production, water conservation, energy efficiency) is hard, and almost inevitably involves a compromise. We do not yet have good methods for determining these compromises and what methods we have involve a considerable degree of human judgement. In practise, however, economics is the driving factor in deciding the trade-off and there is every reason to expect that the increasing diversity of financial products is leaving human judgement out of the equation.
As an example, consider the Snowy Hydro Scheme. According to its own website:
Snowy Hydro Limited is a business providing a complex array of financial hedge and insurance products to participants in the National Electricity Market.
When did Snowy shift from iconic national infrastructure to a provider of hedging products? So much for an engineering masterpiece, the Snowy Hydro has become an investment bank. It appears the prime purpose for the scheme is to longer to regulate flows to the Hume dam, but rather provide financial derivative instruments like options to the power markets.
To do this, in simple terms Snowy Hydro sells options to banks who wish to trade in the electricity market. With electricity pricing able to go from $25MW to $10,000MW almost instantaneously, these options can be a very valuable income source to Snowy Hydro. So valuable in fact, Snowy Hydro may actually profit more by choosing not to generate as much power through water flows. It may also profit more by releasing water to generate power, at a time when downstream catchments are already in flood.
So it would appear the focus of the Snowy Hydro has shifted and the NSW, Victorian and Commonwealth Governments have allowed this national asset to become a financial instrument. This begs the question, which members of state and federal Governments, as shareholders, actually understand how the Snowy Hydro operates? Are they able to measure and report the balance between economic, environmental and social returns from the Snowy Hydro? With the financial returns from power hedging undoubtedly strong and very likely to grow, the concern must be raised that the shareholders, the Governments of NSW, Victoria, and Commonwealth, have accepted a financial dividend over and above any environmental or social dividend possible from this asset. Moreover, if power hedging has detracted from a greater utilisation of Australia's largest renewable energy generator, how has this decision impacted investment in less efficient and more costly schemes to achieve far less carbon emission savings?
The change from national infrastructure to private bank has occurred under the watch of all major and minor political parties. Somewhere along the line Snowy Hydro ceased to be governed along economic, environment and social parameters in the best interest of all Australians. For those thinking this is a one-off in the electricity market, they need look no further than to Hydro Tasmania, built almost exclusively for power generation. The cable connecting Victoria and Tasmania has allowed the Apple Isle to go from low-carbon to a high-carbon financial derivative house.
If the Government is willing to allow infrastructure to be operated for the exclusive benefit of those in the financial markets, what are the downstream implications for Australia's Food Security? What would happen if agricultural assets are allowed to be managed as financial hedging products and not sources of food? This is a serious concern as growing numbers of large foreign investment groups are buying up Australia's agricultural land. The rising prices of food, together with seasonality of production means that financial derivative market instruments that provide incentive for food to be stored rather than consumed in the hope that future prices will be higher are becoming increasingly used. Conventional economic wisdom states that the proliferation of these instruments should result in more stable and hence predictable markets. However conventional wisdom is based on unsound assumptions, and more recent research suggests that proliferation leads to greater market volatility. In the example of Snowy Hydro, greater volatility leads to higher prices for consumers. In the case of Australian food production, where 60 per cent is exported on the global market, greater price volatility leads to hunger and social unrest.
Is it reasonable for access to commodities that provide for the basic needs of life; energy, water and food, to be controlled by an economic system we do not understand? Ecosystem resilience emerges from underlying natural laws that have been shaped by millions of years of natural selection. We may not understand them completely, but we do know that they have given rise to a certain level of global stability and predictability that has allowed the evolution of complex living systems to play out. In contrast, economic systems are run by purely man-made laws that are based on assumptions that we know to be false. The behaviour that emerges is not predictable and subject to catastrophic crashes of an increasingly global nature. Which system of laws would you rather trust the provision of our basic needs to?
Chris Andrew is the CEO of Greenlight Technology Group and Principal of Sustainable Forward Consulting Group. John W Crawford holds the Judith and David Coffey Chair in Sustainable Agriculture, Faculty of Agriculture, Food and Natural Resources at the University of Sydney.
When bankers manage the commons - The Drum Opinion (Australian Broadcasting Corporation)
