How to Strand Assets

In 1849, the wife of an American entrepreneur named Samuel Kier was prescribed “American Medicinal Oil” — petroleum — by her doctor to treat an illness. The Iroquois Indians had used petroleum as an insect repellent, salve, and tonic for hundreds of years. The so-called “rock oil” that naturally seeped out of the ground was viewed as a blessing, and for hundreds of years they skimmed it off the surface of rivers and streams.

With his wife feeling better, Kier saw a business opportunity. He started his own brand, “Kier’s Petroleum or Rock Oil,” and sold bottles for 50 cents through a sales force traveling through the region by wagon.

But Kier was ambitious and sought other uses for his product. A chemist recommended he distill it, and use it as lighting fluid. Kier’s contribution to the emerging petroleum revolution was the creation of the first industrial-scale refinery in downtown Pittsburgh.

Others saw the opportunity created by Kier. A group of New York investors hired an itinerant and disabled engineer with good expertise in salt drilling to poke around in Pennsylvania for petroleum. In 1858, Edwin Drake drilled and hit a gusher of oil, triggering what would be the first of many oil-and-gas based land rushes in American history.

Kerosene rapidly took over the market for lighting fluids in the United States. At its peak, whaling produced 13 million gallons of whale oil annually. The petroleum industry achieved that level just two years after Drake’s oil strike in Pennsylvania. Whalers literally quit their jobs and sought work in the oil fields.

Three years after Drake’s oil strike, Vanity Fair ran a cartoon showing upright sperm whales, dressed in tuxedos and ball gowns, toasting each other with champagne at a fine celebration. The caption read, “Grand ball given by the whales to celebrate the discovery of the oil wells in Pennsylvania.”
“Grand ball given by the whales to celebrate the discovery of the oil wells in Pennsylvannia.” - Vanity Fair, 1861

Twenty-five years before Kier began selling his medicinal oil, the great naturalist and painter John James Audubon wrote in his journal from the deck of his ship approaching England: “What nakedness the country exhibits, with scarce a patch of timber to be seen. [America’s] fine forests of pine, of oak, of heavy walnut trees, of magnificent magnolias, of hickory, or ash, or sugar trees, are represented here by a diminutive growth named furze.”

Today England is verdant, but two centuries after it had begun its transition from wood to coal, the landscape Audubon described was still barren, and forests were kept to supply energy, not as places for wildlife and contemplation.

The rapid transition from wood to coal in the nineteenth and twentieth centuries ultimately would allow England’s forests to recover. Coal stranded the wood fuel industry just as petroleum stranded the whaling industry. In 1900, just 2 to 3 percent of England was covered by forests. Today, 10 to 12 percent is.

Looking back through the lens of our twenty-first-century environmental consciousness, it can be hard to wrap our heads around it, but coal and oil, the steam engine and the internal combustion engine, electricity, roads, and synthetic fertilizer have almost certainly saved more nature than all the environmental laws ever written.

Coal replaced wood for fuel. Petroleum replaced whale oil for lighting before it was in turn displaced by coal-fired electricity. Cars, tractors, and trolleys replaced horses and mules on the farm and in the city as our primary source of motive power, sparing an area the size of California in the United States alone that had been dedicated to growing feed for draft animals. Tractors and fertilizer, together with roads and rail lines that allowed food to get to distant markets, allowed farming to concentrate on the most productive lands, dramatically improving yields and allowing marginal farmland to return to nature.

Nobody at the time thought of the forests, the fields, or the whales that were spared as a result of these world-changing technologies as stranded assets. But surely they were. Nor was any of the stranding a response to environmental concerns, though the environmental benefits that resulted were enormous.

Forest cover recovery due to the rapid transition from wood to coal in the 19th and 20th centuries - Photo credit: Washington Post

1.

The introductory materials for this conference, suggest that “the causes of asset stranding appear to be changing.” Where asset stranding has historically been driven by disruptive technological change — creative destruction, as Joseph Schumpeter famously coined it — the hypothesis presented here is that “environment-related factors are increasingly stranding assets across a wide range of sectors and geographies and this trend is accelerating.”

This claim suggests a much more fundamental shift in the functioning of market economies around the world than might first appear to be the case. Recall that Schumpeter’s signal contribution to the economics canon was his observation that, contra Adam Smith and all the classical economists who followed, disruptive technological change was not something exceptional or external to modern economic systems but rather endemic and endogenous.

The suggestion that climate change and the political response to it has fundamentally altered the basic dynamics of asset stranding suggests both a return to the earlier classical view of technological change and asset stranding as exogenous to the normal functioning of market economies.

Against this notion, let us suggest that any wholesale stranding of fossil energy assets in the coming decades will likely happen in the old-fashioned, Schumpeterian way. By this we mean that large scale asset stranding in the global energy context will remain, as it has always been, primarily driven by technological change. Whether from wood to coal in the nineteenth century or, as is currently underway in the United States, from coal to gas in the twenty-first, the primary driver of wholesale transitions to new sources of energy has been that the new source of energy was not only cleaner but cheaper and more useful.

This will remain all the more the case in a world in which most people still need to consume more energy, not less, in order to achieve modern living standards. Two thirds or more of global emissions in this century will come from developing economies for the simple reason that fossil energy remains the most reliable way, arguably the only way, to move large global populations out of subsistence poverty and into the modern economy. A wholesale transition away from fossil energy will require low carbon energy technologies capable of meeting this demand.

Energy transitions of this nature have, of course, always had a political context. New technologies often require new rules, institutions, and infrastructure to take hold. The diffusion of coal and the steam engine required railways, which in turn required rights of way, concessions, and new laws to advance. Municipal trolleys and public lighting, much more than wealthy private individuals purchasing Thomas Edison’s new fangled light bulbs, were the critical end uses that drove early electrification. The creation of regulated monopoly utilities similarly provided the economic and institutional setting for the broad diffusion of electricity.

But we should never forget that it is the underlying technological capabilities that ultimately make the transition possible. Railways offered a vastly more efficient way to move people and materials over long distances. Electric lighting made it possible to safely light outdoor spaces and allowed factories and other enterprises to operate longer hours. Electric motors brought mechanical power to the city, liberating industry from needing to be in close proximity to waterways with good hydraulic resources. Coal and oil were thermally and spatially far superior to wood and biofuels as primary energy sources.

And indeed, the best contemporary case we have for the stranding of fossil energy assets on a large scale follows the old Schumpeterian model closely. Since 2007, coal-fired generation in the United States has declined from over 50 percent of total generation to less than 40 percent. It is not the case, as some have claimed, that this has simply led to the increased export of coal to other locales. During that period, coal mines have closed and overall coal production has declined significantly, while coal exports have only risen slightly.

The largest single factor in that development has been the revolution in hydraulic fracturing technologies. Natural gas in the United States, once scarce and costly, is today cheap and abundant. Slow economic growth and improving energy efficiency have contributed as well. But while those dynamics have affected clean and dirty sources of energy alike, the growth of natural gas generation during this period has almost exclusively displaced coal generation.

That’s not just because natural gas is cheaper and cleaner. It also requires significantly lower up-front investment in capital than new coal, nuclear, solar, or wind per kilowatt of energy generated, and it is flexible, able to displace both baseload and peaking power stations and ramp up and down rapidly to back up highly variable wind and solar energy generation.

Yet there is more to this story than a driven, independent entrepreneur, in this case the legendary oil man George Mitchell, changing the world. Less well known than his early valorization of the visionary entrepreneur remaking entire industries by inventing disruptive technologies is the fact that by the early 1920s, Schumpeter had become convinced that the age of the lone entrepreneur was over.

With rising technological complexity and scientific specialization, the corporate research lab had replaced the lone inventor as the primary site of technological innovation. Schumpeter was skeptical that corporate managers could bring the same entrepreneurial vision to innovation that had characterized the earlier generation of inventors.

What Schumpeter failed to account for was the increasing importance of the state as a critical driver of mission-driven technological innovation. From jet engines to microchips and the internet to nuclear reactors and solar panels, the unmistakable hand of government has been present in virtually every major technological revolution of the last century.

The shale revolution was no exception. George Mitchell was the first to prove that shale gas could be profitably extracted from the Barnett Shale in West Texas. But that breakthrough was years in the making and was made possible by decades of public research, development, and demonstration programs, hands-on field support, and a longstanding production tax credit.

The diffusion of hydraulic fracturing has also proceeded in a virtuous cycle with environmental policy making and activism. As the cost of shuttering coal plants declined precipitously, stronger air quality regulations and ultimately the Clean Power Plan became feasible politically while local policy-makers on public utility commissions and elsewhere could shut down their coal fleets without overly burdening ratepayers.

This, we would posit, is what any large-scale stranding of fossil energy assets will likely look like — better, cheaper, and cleaner energy technologies will put the wind at the backs of environmental policy-makers, who will in turn enact policies that further accelerate the transition to those technologies.

2.

The substitutions of kerosene for whale oil and coal for wood are frequently thought to be stories of scarcity. “The cost of whale oil rose as the whale population was depleted,” wrote one prominent environmental economist. “Ships had to go further and stay out longer to get their quota. The price rose, only the rich were willing to pay for this luxury good, and so the number of ships declined.”

But the truth is that whale oil scarcity in the nineteenth Century no more gave rise to the kerosene industry than a shortage of Nokia cell phones led Apple to invent the iPhone. Most people never used whale oil to light their homes. It was always a luxury product. By the time kerosene was discovered, there were a number of alternative lighting fuels already in wide use.

By 1860, the markets for both coal gas and lard oil were both larger than the market for whale oil. As early as 1842, a full 17 years before Drake hit oil, the New York Journal of Commerce declared, “the hogs have fairly run the whales out of the market.”

Similarly, it was rising demand for heat, light, and power, driven in large part by new end-uses of energy in the early phases of the industrial revolution, not a scarcity of wood, that drove Britain’s transition from wood to coal.

In Britain, coal substituted for heating in the 1600s, then for charcoal used in ironworks in the 1700s. But what really led to the expansion of coal use was the invention of the steam engine, which became the modern era’s first general-purpose technology powering trains, ships and factories.

Misunderstanding these transitions as primarily stories of scarcity has led many to believe that making nature-destroying technologies scarce — or more expensive — should be the highest goal of environmental policy. It has become accepted wisdom in many quarters of the environmental movement that, properly valued, the services that nature provides us and the costs (or externalities) that environmental degradation imposes ought to be sufficient to justify the preservation of the natural world and elimination of environmental pollutants.

And while there are some cases where explicit valuations of the benefits of nature and the costs of pollution have brought significant environmental improvements, the primary way that we have saved nature and improved environmental health over the last two hundred years has been by rendering land, natural resources, and polluting technologies worthless. Nature made economically useless is nature saved, and polluting assets rendered economically superfluous are assets stranded.

There are two processes through which we strand environmental assets. The first is substitution. Kerosene substituted for whale oil and reduced the hunting of whales. Livestock substituted for bushmeat and reduced the hunting of wild animals. Synthetic rubber substituted for natural rubber, reducing pressure to convert tropical forests to rubber plantations.

The second process is intensification. Fertilizer, irrigation, tractors, pesticides, and plant breeding have allowed us to grow more food on less land. Mining energy rather than growing it has allowed us to free up vast areas of land that was once needed to produce wood and charcoal for heating and cooking and to feed animals that provided motive power.

Substitution and intensification, in other words, have been the primary drivers of environmental asset stranding over time. Most people around the world no longer depend on bushmeat for protein or firewood for heating and cooking.

Even wild catch from the world’s fisheries appears to have peaked, replaced increasingly by aquaculture, which for the first time in 2014 surpassed wild fisheries in total production.

Global farmland too, by some calculations, may be close to its peak, as rising agricultural productivity has managed for many decades now to keep up with, and in many places surpass, rising food demand.

Substitution and intensification also reduce the opportunity costs associated with conservation and environmental regulation. Kerosene may have saved the whales in the nineteenth century, but whaling came back with a vengeance in the twentieth, as better technologies allowed whalers to crisscross the globe in search of whales and kill them with ruthless efficiency.

Yet by the time the first effective international limits were established in the 1970s, most products derived from whales, including meat, margarine, and lubricants, had been replaced by substitutes, and most major whaling nations had already abandoned whaling for economic, not environmental reasons. As a result, the opportunity costs associated with banning whaling were extremely low.

To take another well-known example, New York City famously began to purchase land in the Catskills watershed in the late 1990s to protect its drinking water quality. This case has been widely promoted as a textbook example of saving nature by valuing its services. When the cost of treating New York City’s water is factored into the value of undeveloped land upstate, it makes good sense to preserve those lands for water filtration.

But what really saved the Catskills watershed was agricultural intensification in the late nineteenth and early twentieth centuries. As agricultural yields and better transportation links were established to more-productive farmland in the American Midwest, farmland and dairies across the Catskills region were abandoned. The Catskills Forest Preserve, which constitutes about a third of the watershed, was created in the early twentieth century because the land in the region had lost so much value that landowners ceased paying property taxes on their land. The land became delinquent and reverted to public ownership.

The former town of West Hurley (left) in the Ahokan Reservoir, now part of Catskill Park (right). The purchase of the Catskills watershed for protection was made possible after areas like this were abandoned by landowners seeking more productive farm land -- Image via NYPL Digital Collections

While it is comforting to know that the lands that New York City has purchased more recently are now publicly owned and protected in perpetuity, the land was not actually threatened with development. The City’s land purchase program, in fact, forbade the city from purchasing land for which there was any other bidder. As a result, the average cost of purchase was roughly one hundred times less than the cost of purchasing land in surrounding areas where there was an active market. Once again, we see that what made it possible to formally strand these assets was that the opportunity costs associated with protecting them were already extremely low.

Finally, consider the global effort to eliminate chlorofluorocarbons. The world struggled for the better part of a decade to enact a phaseout of ozone-depleting chemicals. Policies were established in some places, mostly wealthy developed nations, to phase out some uses of CFCs. But lacking a cheap and widely available substitute for critical uses in refrigeration and air conditioning, a global phaseout remained beyond reach. It was not until DuPont demonstrated the ability to produce a cheap substitute at industrial scales that a global phaseout became possible, and within a few years of the announcement that DuPont had done so, a global agreement was in place.

If there is a lesson here, it is that large-scale stranding of assets will not occur by political fiat. The availability of cheap, scalable substitutes will be the precondition to any such future. Carbon pricing, emissions caps, divestment, and all similar asset-stranding strategies will be dependent upon the development of cheap, widely available substitutes.

Low carbon technologies have to date failed to offer a real alternative to fossil energy at scales that would have much impact on climate change. For this reason, decades of efforts to cap emissions internationally and reduce global dependence on fossil fuels have failed to have any impact on global emissions.

If there is reason for optimism, it is that it is not scarcity, but humankind’s quest for more heat, light, and power that has been the main driver of invention and innovation.

We in the rich world have for too long viewed rising consumption as a mere threat and not an opportunity. We have thus sought in a variety of ways to make energy more scarce. But the history of energy transitions and techno-economic paradigms shows that we can take advantage of rising demand to create new substitutes.

And to a great extent, that’s what’s happening. Whether solar or nuclear energy, we are seeing China, the US, and Europe working together to make cleaner sources of energy cheap — not through pricing carbon but by directly investing in those technologies. Just this week we’ve seen Bill Gates announce a project to work with the Chinese government to develop a next-generation nuclear reactor that not only can’t melt down but also recycles waste as fuel. And we have seen three prominent pro-nuclear green activists in Britain call for the UK to abandon its last-generation Hinkley nuclear plant and instead build a next-generation nuclear one.

What’s motivating Bill Gates and pro-nuclear activists here is the same goal: making nuclear cheaper than fossil fuels so it can diffuse around the world and strand fossil fuel assets. These steps mark a new phase in the effort to stabilize carbon emissions. While there remains talk and hopes of a global carbon price, the reality is that we will leave fossil fuels in the ground for the same reason that we left whales in the ocean: because we no longer need them.