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Betting on green

Betting on green

In the 1970s, while studying at the University of California, Doyne Farmer made several trips to Las Vegas. He and two fellow physics students had built a tiny computer to help them predict the spins of a roulette wheel. For a couple of years they enjoyed a tidy profit betting on numbers in the part of the wheel where the ball was most likely to land.

The device was small enough to be concealed in a shoe. So, too, were the toe-controlled switches and transmitters that the trio used to secretly communicate while considering the most promising wagers. On average, the set-up earned a return of around 20%.

Farmer and his associates eventually quit while they were ahead. They did not doubt the effectiveness of their system: rather, they doubted their chances of leaving town with all their limbs intact if their ruse was discovered. There was actually nothing illegal about their gadgetry. But they knew that the typical casino owner of the period was unlikely to find it especially amusing.

Chaos theory

Having tackled the vagaries of roulette, Farmer turned his attention to the then-emerging notion of chaos theory. This is an interdisciplinary field of study that seeks to explain apparent randomness by identifying underlying patterns, interconnections and feedback loops. He used his skills to understand complex markets, founding one of the earliest quant investment firms.

Today, an acknowledged pioneer of the science of complexity, he is the Baillie Gifford Professor of Mathematics at the University of Oxford.

Farmer argues that the ideas behind chaos theory and complexity can go a long way towards helping us understand how the transition to a low-carbon economy might pan out.

If he is right – and, in turn, if much of what mainstream economics has to say about the journey towards net zero is wrong – a decisive shift to green energy could be completed in far less time than even the most ambitious policymakers have dared envisage. In tandem, the demise of fossil fuels and the threat of “stranded assets” could be realised within only a few years.

Is the future closer – and cheaper – than we think?

The list of countries pledging to achieve carbon neutrality by 2050 grows week by week. Even China – which has led the world in consumption of fossil fuels during its meteoric, manufacturing-driven economic rise – hopes to accomplish the feat by 2060.

Such targets are widely regarded as ambitious but Farmer says: “We need to envision a world where most of the power comes from solar, wind, hydrogen, ammonia and maybe other derivative fuels.”

Applying the science of complexity and using models developed for technology forecasting, Farmer, who is Director of Oxford Martin’s Complexity Economics programme, argues that a rapid transition, compared to just continuing with the current energy mix, is the cheapest option and the switch could happen within two decades.

He says: “Fossil fuel prices obviously bounce up and down, but the US Geological Survey reports that no mineral’s price has varied by more than a factor of 10 for over a century. On the other hand, the price of solar photovoltaic systems has come down by a factor of 5,000 since their inauguration in the 1950s; the price of wind power has also come down substantially, albeit not so dramatically; and the price of batteries has come down steadily as well. Meanwhile, the price of nuclear has gone up.”

His confidence is at odds with the prophecies and calculations that more “conventional” analyses have routinely produced. He says these are wrong – they fail to take complexity into account.

Convention versus complexity

William Nordhaus, a Professor of Economics at Yale University, was awarded a share of the 2018 Nobel Prize in Economic Sciences for developing a model to simulate how climate change and the global economy might co-evolve. Although the Intergovernmental Panel on Climate Change (IPCC) has used it to assess the economic impact of global warming, critics claim that his creation is dangerously flawed.

According to Nordhaus’s detractors, it takes scant account – if any – of prospective tipping points that could drastically alter the relationship between the environment and the economy. Some accuse Nordhaus of placing too much stock in “economic rationality” and too little in the quirks and caprices of real-world behaviour.

“Nordhaus’s Nobel Prize is indicative of how bad the economics profession has been in the advice it’s providing,” says Farmer. “He massively overestimates the cost of the transition and massively underestimates the pain of not making the transition. And that’s because his model is ridiculously simple. There’s one representative, rational agent that models the whole world economy and all technology as one thing.”

This, says Farmer, is where taking account of complexity can deliver a valuable edge. “It’s not a matter of just building a more complicated model with more inputs and more variables,” he explains. “It’s about understanding how a shock in one area can cascade into others.”

Farmer notes that his approach is gaining momentum in policymaking circles. “There are central banks that are hiring people with computer science degrees and physics degrees, because they know they need different kinds of models to the ones they have,” he says. “So this stuff is changing. But right now the status quo is still mainly in charge.”

Bottlenecks, busts and blinkeredness

While he believes that it could come about more quickly and less expensively than widely supposed, Farmer cannot guarantee that the transition to a truly green economy will be entirely smooth.

“One of the big challenges will clearly be long-term energy storage,” he says. “That’s where governments should be putting in more support. There needs to be more money pumped in as we start to hit grid capacity in more places, because that’s where a bottleneck might arise – especially if people start wasting energy because it’s so cheap. The good news is that the trends there are pretty good, which means the problems should be solvable – and free capital markets would probably deal with them in the longer run anyway.”

And what about fossil fuels? Farmer is unequivocal. “I think there’s going to be a major crash in the fossil fuel market,” he says, “and I think it’s likely to happen within the next decade.”

Farmer argues that the foresighted fossil fuel companies are well positioned if they really aggressively transition. He says: “They have serious investment capital. If they can actually move their physical assets over from one technology to the other – and get the funding of that right – they potentially will be big winners here.”

Some oil majors are already repositioning themselves accordingly, says Farmer, but others appear oblivious. “I presented our study to some very high-level technical people at one global fossil fuel company last year,” he says, “and they absolutely got it. They said: ‘Wow, this doesn’t look good for us.’ They’re taking steps to remain a big player. But there are some that just don’t seem to get it – and I sure wouldn’t have my money behind them.

“I think the risk of a fossil fuel collapse is very serious,” he says, “and it’s essential that investors are aware of the possibility.”

Professor Farmer was a special guest at our low-carbon world webinar

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