Sunday, November 10, 2013

Dueling forecasts: Why our energy future is actually a risk management problem

Optimistic, but unwarranted, energy supply forecasts permeate the media (courtesy of the oil and gas industry) even as the occasional dire scenario gets coverage. But, it is well to remember that none of the people making forecasts can know the one thing they all desperately want to know: the future.

The most important thing you need to understand about forecasts--any forecast--is that their accuracy deteriorates rapidly, the further they go into the future. Surprisingly, almost no one who makes public energy supply forecasts acknowledges this; otherwise, we would see what statisticians call error bars--very large ones--in all these forecasts. In layman's terms, the further out a forecast goes, the wider the range of possible outcomes--so much so that for long-term forecasts the range of outcomes is far more important than the middle estimate.

But, this kind of waffling doesn't get headlines. Humans are evolutionarily disposed to listen to those who sound the most confident in their pronouncements, not those who are hesitant and full of equivocation. There is reason to believe that overconfidence is an evolutionary advantage, and that this explains its persistence in human society. In addition, research has shown that those projecting confidence engender loyalty even if their forecasts are wrong more often than those who couch their predictions in the language of uncertainty. You can get some of the advantages of being right without actually being right. People like to feel that they are certain even though that feeling often turns out to be false.

So, the lay public is treated daily to an orgy of often contradictory soothsaying and tends to respond as follows: "Come back to me when you know for certain." But, that's just the problem. We can't know anything about the future for certain, and yet we must plan for it. So, how do we go about doing that?

One answer is simply to hope that the prognostications we favor will turn out to be true. It's a hazardous route and requires a good deal of luck. But, a better approach for serious and important matters is to employ risk management. It doesn't tend to generate headlines. But, it can help us better deal with the risks we face on every level.

No one knows whether his or her house will burn down in the next year. It's unlikely, but the damage to life, limb and finances could be very large if it happens. People don't generally go to a forecaster to ask whether their houses will burn down in the next year. Instead, they manage the risk by buying insurance.

So, it turns out that most of us actually do have an intimate acquaintance with risk management in our daily lives through the purchase of insurance. Why don't we take this approach when trying to manage society's large uncertainties such as our energy future?

The answer may lie in the fact that we do not have direct control over such a huge issue, and so we tend to delegate it to others that we regard as experts. Unfortunately, when it comes to energy, the loudest, most confident, and most well-funded voices are those paid for by the oil and gas industry. The practiced confidence of industry executives, captive Wall Street analysts and fake think tank academics has convinced the public that there is nothing to worry about. Just leave the future of energy in the hands of the oil and gas industry, and all will be well.

But, the realities of our energy situation suggest that we should have little confidence in such pronouncements, especially given their self-interested nature. The issue is NOT whether those pronouncements ultimately turn out to be correct, something we won't know until it's too late. The issue is whether the uncertainties we face in energy supply deserve at least the same kind of attention that we give to home and automobile insurance policies.

Here's what risk management in energy policy implies:

  1. We must accept that we cannot know the future with any certainty and that the record of past forecasts demonstrate that we've been too optimistic about supplies for some time.
  2. The risks to energy supply cannot be quantified because there are too many variables that determine the future availability of energy including underground geology, changes in technology, availability of trained personnel, investment and interest rates, energy prices, energy demand, government policy including land use restrictions, wars, social unrest, and environmental regulations including climate change policies. There is simply no way to put all of these into an equation and get a calculable range of supply outcomes.
  3. We must therefore rely on an analysis of the types of risk we face and whether those risks warrant taking out some form of insurance against possible downsides.
  4. The type of risk we face is asymmetrical risk. The downside risk of inadequate fossil fuel supplies needed to run our society could be catastrophic. On the other hand, the cost of transitioning quickly to renewable energy and drastically reducing our energy needs at the same time (which is the safest course) is low compared to the frighteningly high costs of a persistent and unexpected decline in fossil fuel availability.
  5. The trouble with optimistic forecasts of fossil fuel availability is that we can't fix the situation easily if those forecasts turn out wrong to the downside and we have made absolutely no provision for this possibility, that is, we've done nothing to enable us to replace those fuels or to live with less and less of them over time. If we base our policies and actions on such forecasts, they must be right or we are in deep, deep trouble. We should strive instead to create a forecast-proof society.
  6. Therefore, the most prudent course given the stakes is to begin a deliberate, but expedited program of deep energy reductions (through efficiency and conservation), dramatically ramp up the rate of renewable energy production and work furiously to solve the problem of electricity storage since most renewable energy comes in this form.

The complaint is that this will cost a lot of money. But, the oil and gas industry is spending close to $1 trillion a year to maintain a system which is known to have a limited life and the future output of which cannot confidently be predicted. The second complaint is that such a transition will create economic turmoil, throwing into doubt the future of the fossil fuel industry and creating a huge shift in the kinds of skills needed among workers. The real question is whether it would be wise to wait and see just how much chaos fossil fuel decline and climate change cause BEFORE making a commitment to a renewables-based, low-energy economy.

If the optimists are wrong (and they have been on oil since 2000) and if we follow their advice, how will we fix things when we are cascading off an energy cliff? Now is the time to act while there is enough stability to make the indisputably necessary transition. The only question then is timing. So, in the interest of managing risk we should err on the side of being too early (although in my own opinion we are actually already very late).

There is another problem embedded in the forecasting culture (other than the fact that it is dominated by the fossil fuel industry and its minions). Few making the bad calls suffer for them. They have no "skin in the game." ("Skin in the game" here means you participate in a commensurate downside if you are wrong.) Indeed, bad calls may even be rewarded. Oil companies are enjoying large profits even though they predicted low, steady oil prices and ample supply for decades to come at the beginning of the millennium. Far from suffering from their bad calls, they've been prospering. (That will ultimately come to an end as they experience more and more difficulty finding new oil to replace what they're taking out of the ground.)

In fact, the problem of having no skin in the game goes beyond the world of resources. Those who predicted an easy victory in Iraq got to pursue their dream of world domination without any danger to themselves. All the costs were borne by soldiers and civilians in harm's way and taxpayers who financed the fiasco.

What happened to U.S. Deputy Secretary of Defense Paul Wolfowitz who assured Americans that they would be greeted as liberators in Iraq? He was subsequently appointed president of the World Bank. In 2006 ThinkProgress compiled a list of those in the Bush Administration who made optimistic statements and incorrect assessments about Iraq and the invasion. Subsequently, nearly all of those people were rewarded. None in the list ended up unemployable.

The same can be said for Ben Bernanke, U.S. Federal Reserve Board chairman, who opined in a 2007 speech, "[W]e believe the effect of the troubles in the subprime sector on the broader housing market will likely be limited, and we do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system."

He continues to be the chairman to this day and is even hailed as a hero for saving the world economy from a depression during the 2008 crash. There was not even a hint of irony in this pronouncement even though it was Bernanke's and Alan Greenspan's expansionary monetary policy (while Bernanke served on the Federal Reserve board) which helped to create the mortgage bubble that ended up bursting and severely damaging the world economy--and even though Bernanke assumed the subprime crisis would not affect the broad economy and guided monetary policy accordingly.

It's no wonder then that we get such bad public policy and such reckless financial and political behavior. You should not try to manage risk based on the pronouncements of those who have no skin in the game. They won't be careful. Just the opposite. They will often be reckless in pursuit of their own interests as long as someone else has to pay the bill when things go wrong. And, you can't manage risk based on the idea that you can know anything for certain about the future. If you knew things for certain, there wouldn't be any risk.

Too many people believe that public policy is made on the basis of certainty. Hence, my generic member of the public quoted above as saying, "Get back to me when you know for certain." The better course is to create systems that don't require forecasting, that are stable enough to withstand those events which we cannot predict and which might even grow more stable from such perturbations. But, that's a topic for another piece.

Kurt Cobb is an author, speaker, and columnist focusing on energy and the environment. He is a regular contributor to the Energy Voices section of The Christian Science Monitor and author of the peak-oil-themed novel Prelude. In addition, he has written columns for the Paris-based science news site Scitizen, and his work has been featured on Energy Bulletin (now Resilience.org), The Oil Drum, OilPrice.com, Econ Matters, Peak Oil Review, 321energy, Common Dreams, Le Monde Diplomatique and many other sites. He maintains a blog called Resource Insights and can be contacted at kurtcobb2001@yahoo.com.

3 comments:

Shawn B said...

Kurt

Excellent Post, as usual.

Risk Management approaches are well established in some industries/technologies, even by some urban planners. By military organizations also. Do we know, has the U.S. Gov. ever done such an national energy risk management assessment and program and published it? (From Wikipedia, a high level summary of Risk Management method: “1. identify, characterize threats, 2. assess the vulnerability of critical assets to specific threats, 3. determine the risk (i.e. the expected likelihood and consequences of specific types of attacks on specific assets), 4. identify ways to reduce those risks, prioritize risk reduction measures based on a strategy.”)

These are mostly rhetorical questions, no reply is expected…. Would the Gov. publish (fully) such an risk assessment/plan? (I am thinking here of Dick Cheney’s secret commission?) I have not made my way fully around this site, http://www.eia.gov/ but there are hints that some of this kind of thinking goes on with the U.S. Government. Maybe somebody has a grand plan? Or maybe it is just a hope and pray strategy (because there really is no way politically palatable way to mitigate the downside of oil running short/price goes too high?) The 2005 Energy Policy Act seems to express some aspects of a risk reduction plan, although surely bent and distorted by industry lobby groups.

Cheers.

Shawn

Walter said...

Well Kurt, you lose me and quite a few other anthropologists when you start with accepting sociobiology and evolutionary psychology (a kinder, gentler sociobiology) at face value.

Kurt Cobb said...

Walter is right to be concerned because many believe that in order to entertain the possibility of evolutionarily adaptive psychological traits, one must throw out all other influences on human psychology. I don't, and I think our evolutionary background is but one factor among many that determine the psychology of the individual. But, when one sees a persistent psychological trait among large numbers of humans across time and space, it is reasonable to infer a common and perhaps noncultural explanation.

In any case, whatever the cause of human anxiety over uncertainty and undue deference given to those who project certainty, it is an observable phenomenon and contributes to the persistence of error in modern communications.