Weather futures contracts show that traders are already building expectations of climate change into the way they invest their money.
Full Transcript
Ross Kenyon: Hello and welcome to Carbon Removal Newsroom. I am Ross Kenyon, lead strategist with the Nori Carbon Removal Marketplace. Today I have with me Ronald Bailey, the science correspondent at Reason Magazine and Reason.com. Ronald, you had a great article come out last week called The Market Says Climate Change is Happening. How exactly does that work? How could the market tell you such a thing? What’s happening with that?
Ronald Bailey: I wrote the article based on a wonderful new research paper done by economists with the National Bureau of Economic Research. And what they were looking at are price trends on the Chicago Mercantile Exchange for weather futures contracts, those weather derivatives. And what they find is the prices on those contracts are mirroring the predictions that were made by cotton bottles over the last 15 years or so. But basically, prices are doing...
Ross Kenyon: So for listeners for whom weather derivatives might be a bit of high finance esoteric magic, how exactly do they work?
Ronald Bailey: Well, what they basically are doing are measuring what are called cooling degree days and heating degree days. And what people who are worried about, for example, how much heating oil they have to buy or how much coal they might have to – or natural gas they need to stock up to generate electricity to take care of the heating needs of their customers or their cooling needs of their customers in the summer – They’re trying to hedge against that and make sure that they can smooth out the price, if you will, of the energy that they’re paying, for which they’re paying.
And so these contracts work as hedges. And if you get it right, you can make a considerable amount of money on that and also save your company a great deal of money. Farmers also use this in order to get some idea of how to smooth out, if you will, their grain prices in order to avoid the fluctuations of droughts or floods and that kind of thing. So it may sound a little highfalutin, but it’s actually a pretty clear notion, if you will, insuring against changes in the world.
Ross Kenyon: I see. And do you think that there will be other markets that arise to track changes in securities, commodities, derivatives that relate to climate change? Do you think the market will continue to contribute this information through prices about the changing climate?
Ronald Bailey: I do think that will happen in some regards. For example, already we can see, and there have been several studies showing, for example, that coastal properties, prices are going down in those regions where sea level is rising. And one of the consequences of global warming is that sea levels will rise as glaciers melt, for example, and add more water to the oceans over time. And already we see this happening as people are incorporating, if you will, the risks of coastal flooding into their purchases of beachfront property.
Ross Kenyon: Yes, and that makes sense. I’m not sure right now is a great time to be buying beachfront property. That seems like a tough market to be in if you had to be selling. One of the things I really like about this story is that I see a lot of people, primarily economists, a lot of them at George Mason actually making these predictive bets about future activities, the frequency of them, and putting their money where their mouth is with a concrete bet that can be tested. And of course, this harkens back to at least Paul Ehrlich and Julian Simon’s famous bet.
But I just love this about prediction markets and people being able to put your money where your mouth is. If you think climate change is a hoax or is not nearly as bad as some people claim, then you stand to make a great deal of money when these empirical facts back you up.
Ronald Bailey: I completely agree with that. The great thing about the Chicago Mercantile market is it is already existing and it’s millions and millions of dollars are turning over there. So people are actually putting their money on the line with regard to their predictions with climate over time and weather on a yearly basis. One thing about many prediction markets at this point is they’re pretty thinly traded and one of the advantages of something like the weather derivatives market is that it’s much more robust.
Ross Kenyon: I know prediction markets have been a bit hobbled by regulation and haven’t really shown their full potential yet. And what we’re describing with the derivatives is not actually a prediction market. They’re just maybe cousins. But I could imagine in the future predictions. I think it would help communicate more information about climate change.
Unknown speaker: One of the things I understand is holding back prediction markets are regulations that treat them as though they were, if you will, betting markets.
Ronald Bailey: There are regulators who are very, if you will, concerned that people will be turning these things into casinos of some sort. I don’t see that as a problem, again, because we who are watching these things, if we’re not participating in the market, we’re still getting information about what people who are presumably more knowledgeable think about what the trends will be, and we could also act on that as well. It’s a signal to the rest of us.
Ross Kenyon: Yes, that seems wise to me. Okay, I have a question that’s a little bit of a stretch, but it’s Carbon Removal Newsroom, so I am obliged to ask. If the market is saying that climate change is happening, this is being confirmed, and people are making money based on that prediction, and it’s too late to merely mitigate for climate change and reduce emissions, does that mean that the market may be receptive to projects that involve carbon removal in the future? Do you think they might be more likely than otherwise to see the value in such a pursuit?
Ronald Bailey: I think that’s likely. Again, it will depend upon prices, if you will, the cost of adaptation versus mitigation versus removal. And again, these things will be determined by the market. If, for example, there’s a carbon price of $100 a ton per carbon emissions out there, and you can remove it for $10 a ton, then obviously removal becomes a real player in that category.
Ross Kenyon: Great. Well, I am happy to hear that for both personal and climatological reasons. I hope that is the case. Ron, thanks so much for being here with us. That was very interesting. I like that we have a chance to dig into articles such as this. I think people betting on things is a good way to separate the fluff from actually what we want to see. And I like that. And I hope you’ll continue covering this beat and we’ll continue reading your work. So thank you so much for being here with us, Ron.
Ronald Bailey: I’m delighted to be with you. Let’s talk again sometime soon.
