Systemic Implications of the Energy Meltdown
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The document discusses managing emerging systemic risks, specifically related to the global energy meltdown that began in 2014. It analyzes the systemic implications of this event, including the risk of "stranded assets" as the cost of fossil fuels increases due to carbon pricing. Various graphs show the correlation between falling oil prices and other asset classes like bonds and currencies. The conclusion calls for taking an adaptive approach to stress testing in order to better detect systemic risks early through connecting the dots between different risks and amplifying social intelligence around emerging threats.
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Systemic Implications of the Energy Meltdown
- 1. MANAGING EMERGING SYSTEMIC RISK 1 Alan Laubsch Director, VP of Risk Products View of smoke plumes emitted from the Syncrude upgrader plant north of Fort McMurray, northern Alberta, Canada. Photograph: Jiri Rezac/Jiri Rezac. Source: guardian.com Systemic Implications of the Global Energy Meltdown
- 2. 2 Market linkages Clustering Bilateral exposure data Asset price data Balance sheet data Financial Cartography reveals connected risks and hidden patterns Central nodes
- 3. 3 How can we best manage emerging systemic risk? As in healthcare, our best chance lies is early detection Source: MULTIPLE SCLEROSIS: ORIGIN OF ABNORMAL CELLS FOUND, UC DAVIS (2011)
- 5. 5 What Precipitated the Energy Tipping Point in 2014? Systemic implications?
- 6. 6 Canary in the coal mine: Energy
- 7. 7 Classic contrarian phase transition 1. Low vol (complacency) 2. Peak prices 3. … and then an outlier
- 8. 8 24 June Risky Business Report
- 9. 9 Divestment Tipping Point Litterman believes an immediate risk that investors should address is the potential for "stranded assets," or energy sources companies will not be able to harvest as the cost of oil, natural gas, coal and other fossil fuels increase from carbon-related taxes. "It's a risk management issue. Fossil fuel companies aren't evil or bad— they're acting rationally given the wrong incentives. The incentive to emit is not being penalized today," Litterman said during a panel discussion on money management in the face of global warming. "The risk that investors have in their portfolios is not climate risk, per se, it's the risk that assets will be repriced because appropriate incentives are created globally to conserve on emissions."
- 10. 10 Train Wreck Source: Bob Litterman: The Price of Climate Risks
- 11. 11 Stranded Asset Swap Source: Bob Litterman: The Price of Climate Risks
- 12. 12 22 Sep 2014: Rockefellers Divest “John D Rockefeller, the founder of Standard Oil, moved America out of whale oil and into petroleum….We are quite convinced that if he were alive today…he would be moving out of fossil fuels and investing in clean, renewable energy.”
- 13. 13 9 Oct Risk Crescendo
- 14. 14 Oct 9 Energy as worst performer
- 15. 15 Oct 9 Energy EAFE correlation
- 16. 16 28 Nov Black Friday
- 17. 17 28 Nov Black Friday
- 18. 18 Given inevitability of carbon pricing, was OPEC’s decision surprising? Given that we have exceeded safe levels of atmospheric CO2, carbon pricing or limits are inevitable. Paradoxically, until these costs are imposed, producers will keep pumping
- 19. 19 Black Friday cascaded into 10-15 Dec EMBI & Russia Crisis
- 20. 20 15 Dec Oil & EMBI correlation peaks
- 21. 21 Predictive Stress Black Fri 28 Nov 2014: - 3sd Oil & Energy
- 22. 22 Predictive Stress 9 Oct 2014: -3sd Oil & Energy
- 23. 23 Systemic Risk Escalating in 2015
- 24. 24 Energy & Junk bond correlation still high
- 25. 25 30 Jan: Oil up 6.6% but bottom unlikely Dead Cat Bounce?
- 26. 26 Predictive Stress 30 Jan 2014: -3sd Oil & Energy… some decoupling
- 27. 27 Energy (XLE) vs S&P 500 Asymmetric downside beta since 24 Jun 2014 Peak Energy
- 29. 29 Subprime Energy Bubble Bust Carbon intensive industries/countries most vulnerable - Equity, Credit, FX. - Commodity bubble bust? Materials 2n order effects: Financials exposed to Energy & Materials? Utilities? Liquidity risk. Monitor systemic risk & focus on early warning
- 30. 30 Disruptive Energy “Dragon Kings” The future is already here. It’s just not very evenly distributed. - William Gibson Alternatives Divestment Carbon Price
- 31. 31 Adaptive Stress Testing Source: Wikipedia; see Geoffrey Moore’s “Crossing the Chasm” (1999)
- 32. 32 Conclusions 1. See a Connected Picture of Risk 2. “Sense and Respond” 3. Amplify Social Intelligence
- 33. 33 FNA Alan Laubsch Director & VP of Risk Products alan@fna.fi www.fna.fi Thank You
Editor's Notes
- Good Evening and thank you to everyone for coming on this cold day. We chose a special time to visit NY! What doesn’t kill us makes us stronger! The broad topic we’re all here to discuss is Managing Emerging Systemic Risk. As in healthcare, our best chance at mitigating systemic risk is early detection and action. My focus will be on the Tipping Point we saw last year in Energy Markets, and to present some information gleaned from network science that I hope will add to the information we’ve gotten from media and energy pundits. —- Network science allows us to harness social intelligence. We live in an intelligent universe. Intelligence pervades within and without, in our minds and in the broader marketplace. We are swimming in intelligence. And yet each of us has only a limited view, a little pinhole to look at the world. A world which faces major systemic risks. Our vision at FNA is to build social intelligence platforms to harness the intelligence of visionary thinkers and signals of the marketplace to better manage systemic risk.
- At FNA we’re map makers. Maps amplify intelligence. They allow us to see hidden patterns in complex data. How are risks connected, and how do they evolve in a complex non-linear network?
- This is an image of a brain scan showing abnormal cells in that are early warning signals for MULTIPLE SCLEROSIS in a recent study from UC DAVIS. There are so many parallels between systemic risk management and healthcare. Because our ability to control goes down exponentially after tipping points are crossed, our best chance lies is early detection and action. And the good news is in both finance and healthcare we’ve started to build useful diagnostic tools that allow us to better detect unhealthy patterns early. Posted by Phyllis Brown-UC Davis on August 30, 2011
- The Price of Climate Risks - Bob Litterman
- The Rockefeller Brothers Fund is now one of 180 institutions and local governments and 654 individuals who have so far pledged to cut investments in 200 coal, oil and gas producers from their asset holdings. Total divested funds are $50 billion, as commitments to sell have doubled so far this year, according to Arabella Advisors, which works with philanthropic groups on their investments. The World Bank corralled more than 1,000 companies and investors in support of a carbon price, which means either a tax on carbon or a cap on carbon and an emissions trading system, including companies such as Unilever and Swiss Re. Countries such as Russia and China also signed on to the pledge.
- We live in an increasingly complex and fast moving world. Predict and control no longer works. A more sensible approach is Sense and Respond. A mountain biking race would be a good analogy. Of course we do all the homework and map out the course, get GPS and weather forecasts. But what makes the real difference is executing on the course, sensing and responding to the changing conditions of the course. This is a paradigm we will take to stress testing.
- - Coal, Tar Sands, Shale, Deep Sea Exploration - Materials. Utilities? - Russia, Brazil, Mexico, Australia, Canada - Junk bonds - EM bonds - Financials with Energy Exposure
- There are three major disruptive Dragon Kings, as Didier Sornette calls them. These are characterized by small changes that amplify super-exponentially to become major forces that drive the world. Last year markets a tipping point in divestment with leading endowments, and ever more are signing up. Of course Hedge funds have seen this and many hopped aboard too. The growth in alternatives is important, especially solar. Oil is competing with technology that is getting exponentially better and cheaper. Solar is either at or will be at grid parity within the next couple of years, with costs continuing to decline. Improving Battery technology and EV has the potential to radically transform the landscape. And finally, there’s the pricing and limit of carbon, which has the potential to strand over 75% of the industry’s energy assets. Energy producers recognize this, and will therefore keep pumping as much as they can until those costs are actually imposed.
- Identify where we are in the business growth cycle (from macro to sector & firm level) Diffusion of ideas and innovation in societies follow exponential growth patterns also seen in epidemiology Monitor factors that change contagion rates and “tip” epidemics Malcolm Gladwell’s “Tipping Point”: Connectors, Mavens, Salespeople How is today’s financial fashion evolving? Monitor factors that change contagion rates and “tip” epidemics How is today’s financial fashion evolving?
- We live in an increasingly complex and fast moving world. Predict and control no longer works. A more sensible approach is Sense and Respond. A mountain biking race would be a good analogy. Of course we do all the homework and map out the course, get GPS and weather forecasts. But what makes the real difference is executing on the course, sensing and responding to the changing conditions of the course. This is a paradigm we will take to stress testing.