Agenda -Part 2

1
Agenda -Part 2
1125-1130 Overview on Part 2 1130-1145 Insura
nce managers - Daniel Hoffmann and Granger
Morgan 1145-1200 Questions and
Discussion 1200-1215 Forest, fisheries and
ecosystem managers in the Pacific Northwest and
Western Canada -Tim McDaniels 1215-1230 Quest
ions and Discussion 1230-1300 Lunch
2
Part 2 Studies of Decision Makingin Four
Specific Contexts
We've proposed to study four specific decision
contexts. The point of this part of the project
is to examine a set of specific settings in which
climate is likely to be very important, and the
decision-making implications of our limited
ability to make predictions about future climate
can be worked out in detail. For that reason we
have been very careful to select settings in
which we think climate will play an important
role insurance industry (potential large
liability exposures) the high arctic
(anticipated large climate changes). high
latitude forest and fishery resources
(anticipated substantial impacts). power
industry (probably will take the brunt to early
serious controls).
3
Climate is only one variable
While we have been careful to select decision
contexts in which we believe that future climate
is likely to be a major factor, it is important
to remember that even in these cases climate is
not the only thing that will change over coming
decades. Indeed, often, even in these cases,
climate is likely to be of second order
importance compared with other important
variables such as new technology, changing public
policy, changing economic relationships, and
social and instructional infrastructure.
4
Decision case studies(Cont.)
While climate, and possible future climate
policy, can impose stress on social, economic and
ecological systems, so too can many other
factors. Just as there are limits to our
ability to make predictions about future climate,
so too there are limits both to our ability to
identify likely sources of future stress, and to
make meaningful predictions about those stresses.
However, with some effort, at least some of
these can be identified, and when possible, be
generalized.
5
Decision case studies(Cont.)
Typically, we will not use detailed scenarios but
rather will use simpler parametric methods.
Thus, for example, if future natural gas prices
look to be critical to a specific class of
decisions, in the projects in Part 2 we will not
develop long detailed stories about how those
prices might be shaped by future technology and
by developments in the US, Europe, the Middle
East and the Former Soviet Union but will simply
truncate the causal chain, posit a range of
possible future oil prices, and work from
there. Later of course, outputs from Part 3 may
help us refine this treatment.
6
Decision case studies(Cont.)
Once results from the climate science elicitation
studies from Part 1 become available, we will use
them, along with the other sector-specific
information we have developed, to begin to create
a set of decision support tools that are
appropriate given the limitations on the
predictive information that we are likely to be
able to acquire. As results become available
from the work in Part 3 of the Center's research,
these tools will be modified to incorporate
additional information and uncertainty about
climate policy and its impacts. Different tools
will be developed in different contexts depending
upon the details of the sector and the problems
they face.
7
Agenda -Part 2
1125-1130 Overview on Part 2 1130-1145 Insura
nce managers - Daniel Hoffmann and Granger
Morgan 1145-1200 Questions and
Discussion 1200-1215 Forest, fisheries and
ecosystem managers in the Pacific Northwest and
Western Canada -Tim McDaniels 1215-1230 Quest
ions and Discussion 1230-1300 Lunch
8
Climate Change and Global Warming Risks to the
Insurance Industry
9
Climate Change and Global Warming A Fact to
Reckon With
1870 Rhone Glacier, Switzerland
1999
10
and the same here Grinnell Glacier and Lake
(1910 to 1977)
Pretty soon we will have to settle for
Non-Glacier National Park!
11
Overview - The Insurance Industry

• Primary Insurance Carriers
• Business Area short- and medium-term risk
• Products Health Life, PC
• Backstop provided by Reinsurance Carriers
• Reinsurance Carriers
• Business Area Backstop for primary carriers
• Long-term, catastrophic, specialty, and high
  exposure risks
• Products CAT insurance, high excess, specialty
  products (BI, DO, ART, derivatives, guaranties,
  bonds), asset management

12
Financials of the Insurance Industry

• Revenue and Assets
• Revenues from premium and investments
• Premium Revenues US2.2T global
• Assets (U.S. Life Insurance companies only)
• Total US2.8T
• Real Property Holdings US60B
• Equal to 15 of total assets and reserves of
  major pension funds and retirement programs
• Return on premium mostly negative (ratio 1.06)
• Return on Investments/Assets Profitability
• (Source Innovest, personal communication, 2003)

13
The Dawning in the Insurance Industry

• The insurance business is first in line to be
  affected by climate change. It is clear that
  global warming could bankrupt the industry
• Franklin Nutter,President,
• Reinsurance Association of America, 2003
• Why?
• - Climate Change is a global phenomenon,
• - The Insurance Industry is a global player

14
Awareness of the Insurance Industry

• Primary Insurance Companies
• Late in awareness
• Reason Revenue and Assets
• Awareness increases due to exposures in liability
  coverage
• Reinsurance Industry
• Highly aware overall, as risk research/quantificat
  ion has shown increased exposure
• Leaders Munich Re and Swiss Re
• Implementation of programs to
• Limit risks
• Assess business opportunities

15
Source J. Holdren, KSG, Harvard University
16
Potential Climate Change Cost
17
Threats to the Insurance Industry

• Liquidity Risks
• Investment Portfolio Risks

18
Exposure of the Insurance Industry

• Property and Casualty (PC) Insurance
• Physical Damage to Property due to increased
  Frequency and/or Severity relating to
• Flooding as a result of increased
  precipitation, rise in sea level and change of
  weather patterns
• Storms as a result of change in ocean
  currents/weather patterns
• Compounding loss effect as a result of
  increasing population, infrastructure density,
  increase in property value, and event
  characteristics

19
Exposure of the Insurance Industry
in billion US, 2001 prices. Source Swiss Re
sigma
2001 11 Sept

• Upward trend expected to continue
• higher insurance penetration
• growing values
• value concentration in coastal areas
• changing hazard cycles and trends, e.g.
  natural man-made climate change

60
1992 Hurricane Andrew
1999 Storms Lothar/Martin
50
Total Estimated Loss US38 to 50B, incl. third
party liability
1994 Northridge Earthquake
40
30
20
10
0
1970
1975
1980
1985
1990
1995
2000
Man-made catastrophes
11 September loss(property and business
interruption)

• Worldwide economic losses due to natural
  disasters appear to be doubling every 10 years
  and next decade will reach US150B
• Source UNEP Financial Initiatives Climate
  Working Group Report 2002

20
The Reinsurers Speak
Relating to PC exposure, Munich Re reported that
natural disasters caused US55B in damage in
2002, primarily related to weather-induced
property damages across France, Austria, Poland
and Italy.
Percentage Distribution Worldwide
Source http//www.munichre.com/pdf/natcat_natural
_catastrophes_2002_e.pdf
21
Exposure of the Insurance Industry

• 2. Health and Life Insurance
• Increased risk to human health as a result of
• weather/climate patterns
• Thermal Stress
• Natural Disasters
• Vector-borne Diseases (see next slide)
• Mortality Rates

22
(No Transcript)
23
Exposure of the Insurance Industry

• Other Exposure
• As a result of change in frequency and severity
  of events
• due to climate change, unpredictability of loss
  exposure
• relating to the following exposures
• Business Interruption
• Agro/crop loss
• Existing CAT coverage
• Weather derivatives
• Project finance
• Directors Officers (DO)
• Errors Omission (EO)
• Technology relating to carbon mitigation and
  associated technologies

24
In Summary

• It is estimated that US2.7 trillion of the 10
  trillion U.S. economy is susceptible to
  weather-related loss of revenue, meaning that an
  enormous number of companies have "off balance
  sheet" risks related to climate
• John Dutton, Dean Emeritus
• Penn State's College of Earth and Mineral
  Sciences
• Of this amount
• the exposure for the global insurance industry
  is approximately US800 billion to US1 trillion,
  a significant Liquidity Risk!

25
Can there be any other potential threats to the
insurance industry? You betcha!
26
Yes, and they might be big!

• Do you recall Dean Duttons statement?
• It is estimated that US2.7 trillion of the 10
  trillion U.S. economy is susceptible to
  weather-related loss of revenue, meaning that an
• enormous number of companies have "off balance
  sheet" risks related to climate

27
Threats to the Insurance Industry

• Liquidity Risks
• Investment Portfolio Risks

28
The Insurance Industry

• is a major investor as well as a Third Party
  Administrator.
• U.S. life insurance companies ALONE
• Have assets in excess of US 2.8T
• Account for 14 of the total assets/reserves of
  major pension funds and retirement programs
• Have fiduciary responsibilities as a Third Party
  Administrator for approx. US300B in assets under
  management
• and because the above is for U.S. life
  insurance companies only, that is only the tip of
  the iceberg

29
Exposure of the Insurance Industry

• 4. Value of Assets
• Unless, rigorously evaluated from a prospective
  threat
• emanating from emission of greenhouse gases (GHG)
  
• resulting in climate change, the value of the
  assets could
• be impaired due to
• Direct but Hidden (Off-Balance Sheet) Carbon
  Liabilities affecting the market value of the
  assets securities
• As a result of potential disclosure
  requirements/regulation of GHG, the carbon
  exposure of GHG-emitting companies could be as
  high as 35, resulting in a financial risk of up
  to 10 of current market value (Source
  Innovest, personal communication, 2003)
• Extra cost associated with climate change The
  water industry could face additional cost of 47B
  by 2050 and 1T by 2070
• (Source J.T. Houghton, Climate Change 2001,
  Oxford University Press)

30
Exposure of the Insurance Industry

• 4. Value of Assets Part II
• Indirect Effects of Climate Change, affecting the
  market value of the assets securities
• As a result of more complex climate variations
  and its effects, increase of cost to doing
  business (COGS), resulting in increase of Assets
  liabilities.
• Ex 1 Fishing Industry As a result of current
  changes, increase COGS to new fishing
  areas/potential loss of fishing at all.
• Ex 2 Agriculture/Food As a result of
  temperature and precipitation changes, increasing
  unpredictability of crop yield, resulting in loss
  of market share
• Ex 3 Basic high energy consuming Industry
  (Steel, Chemicals) As a result of increased
  energy cost, emanating from the power companies,
  COGS will increase
• gt Increased COGS will result in Loss in Market
  Value of Assets

31
Exposure of the Insurance Industry

• 5. Value of Insurance Industrys Securities
• The largest and ultimate threat to the Insurance
  industry and, thus in the value of its own
  securities is based on a timing issue.
• In fact the timing issue relating to climate
  change, if not properly prepared for by the
  insurance industry at large, may become its death
  knell.
• The ultimate threat is the compounding effect of
  a
• CONVERGENCE
• of liquidity (underwriting) exposure
• AND
• of investment portfolio exposure

32
Who is Aware of this?
Insurance Analysts As a result of larger
exposures of the industry in 2001, insurance
analyst at Lehman Brothers lowered earning
estimates to account for higher-than normal
level of catastrophes (FT.com, April 27,
2001) Can you imagine the reaction when
Convergence starts to affect the Industry?
33
and Increasingly the Insurance Industry
The insurance business is first in line to be
affected by climate change. It is clear that
global warming could bankrupt the industry
Franklin Nutter, President Reinsurance
Association of America
34
Plans for Research on Insurance
Building on the initial results of the other work
of the Center we will prepare a background paper
in which we will develop a preliminary taxonomy
of the climate-related risks and opportunities
that confront the insurance industry, and suggest
a preliminary set of decision analytic and other
tools that could help the industry to better
understand and think about these issues. In
refining this paper we will be assisted by
several industry experts including Richard (Rich)
Soja and Peter Thompson in Chubb's global
property underwriting department in Warren NJ,
and Mike Ewbank an energy underwriting specialist
in Chubb's Chicago IL office, Howard Kunruther at
Wharton, and a number of Daniel Hoffmann's
professional contacts.
35
First Expert Workshop
We will then convene a small invitational
workshop with participants drawn from leading
insurance, reinsurance, capital investment and
risk assessment firms. We will use the workshop
to revise and refine the taxonomy and define an
appropriate set of analytical needs. The result
will form the basis of the research agenda for
years two and three, during which, in
collaboration with several experts from the
industry, we will undertake a program of
systematic analysis and tool development. With
assistance from Paul Fischbeck, this may include
work that makes use of real options.
36
Insurance(Cont.)
While much of this work may involve the
application of existing analytical methods, given
the high, and likely irreducible, levels of some
of the relevant uncertainties, it seems probable
that there will also be a need for the
development of new tools and methods (such as
those employed in our previous work on mixed
levels of uncertainty and bounding analysis).
However, the specifics should be driven by the
needs identified by key actors in the industry.
37
Examples of Possible Analysis
How adequate are current efforts to rate the
climate-related vulnerabilities for investments
by major industrial sector? What could be done
to improve such measures? How soon, and to what
extent, will it be possible to know the
contribution that climate change makes to weather
related losses? (How big would they have to be
to be detectable? How does this compare with
what we can hope to know?) What are specific
insurance/investment risks in the arctic
(shipping in NW passage structures on
permafrost) to NW timber holdings to power
company's asset values?
38
Examples (Cont.)
Losses from catastrophic weather events 1950-2000

• While many in the industry believe that recent
  escalating weather related losses are driven by
  climate change, many of the climate data don't
  support this conclusion.
• We need to look at
• adequacy of risk assessment tools
• the way those assessments are being used
• risk portfolios.

Atlantic hurricane frequency 1948-2001
Source IPCC (above) NOAA (below).
39
Second Expert Workshop
At the end of year three, with preliminary
results in hand, we will convene a second
workshop at which we will expose our work to
critical review by experts from across the
industry, and seek advice on how it should be
revised, redirected, and extended. We will
communicate our results and seek input and
involvement from the expert and lay communities
concerned with insurance/investment matters
via The two workshops described. Professional
and popular publication. Briefings to relevant
government and private-sector decision makers.
40
Agenda(Cont.)
Part 2
1130-1145 Insurance managers - Daniel
Hoffmann and Granger Morgan 1145-1200 Questions
and Discussion 1200-1215 Forest, fisheries
and ecosystem managers in the Pacific Northwest
and Western Canada -Tim McDaniels 1215-1230 Qu
estions and Discussion 1230-1300 Lunch 1300-1
315 Arctic-region decision makers - Hadi
Dowlatabadi 1315-1400 Questions and Discussion
41
Agenda -Part 2
1125-1130 Overview on Part 2 1130-1145 Insura
nce managers - Daniel Hoffmann and Granger
Morgan 1145-1200 Questions and
Discussion 1200-1215 Forest, fisheries and
ecosystem managers in the Pacific Northwest and
Western Canada -Tim McDaniels 1215-1230 Quest
ions and Discussion 1230-1300 Lunch
42
Basic Issue

• How to manage ecosystem harvests (forestry,
  fisheries), and the dual objective of maintaining
  rich ecosystems and biodiversity, given
  irreducible uncertainties about climate, and a
  host of other uncertainties regarding ecological
  systems, resource productivity, values, markets,
  and many other important influences?

43
Context

• Forestry how we harvest the eco-productivity of
  non-agricultural land ecosystems
• Fisheries how we harvest aquatic ecosystems
• Given the scale of harvest systems, these
  economic harvest flows potentially conflict with
  ecosystem and biodiversity preservation
• a constant tradeoff for managers, affected
  publics, NGOs, concerns about eco-service flows
• Forest land is more privately owned in WA and
  Oregon, nearly all public in BC

44
More context

• These harvest systems are always subject to
  massive uncertainties
• scientific, social, economic and institutional
• Management has been, in technical terms, as if
  uncertainties were minimal linked to short term
  political and economic objectives
• Growing involvement of civil society advocating
  stronger preservation orientation, growing
  emphasis on new institutional structures to
  address conflicts

45
Recognizing Irreducible Uncertainties

• Acknowledging IU about climate means we face
  issues of uncertainty about biodiversity
  preservation, and continuity of economic flows in
  these systems much more directly and likely with
  much greater potential loss over next century or
  so.
• How to design, compare, build broader technical
  and societal support for management alternatives
  given this context?

46
Feedbacks and interrelated effects

• Climate (specifically winter temperature) affects
  pine beetle infestations
• Infestations kill trees over huge areas, change
  land cover, create massive fire hazards, but
  still allow harvest
• Will change species mix, age classes
• Accelerates and then reduces harvests
• Creates massive ecosystem change in parks

47
Interrelated effects (cont.)

• Glacial runoff will decline (to zero?) in coming
  decades
• Effects on habitat at mid-high elevations will be
  fast and huge
• Reduced Sp/Su flows in major rivers
• Columbia River example changes in storage
  requirements, fish flows, flood control, fish
  production could all be substantial
• These are already enormously contentious, complex
  decision processes, subject to heavy constraints

48
Decision Analysis Challenges

• Value tradeoffs biodiversity objectives,
  economic objectives, flexibility, learning
• Creating alternatives characterizing complexity
  robust, adaptive approaches societal learning,
  across whole domains and regions
• Decision processes that involve civil society
  groups, managers and technical specialists

49
Our basic approach

• Model archetypes of management decisions in each
  domain
• Influence diagrams, consequence tables, expert
  elicitations, some DA modeling
• Define robust strategies that characterize
  different fundamental approaches and illustrate
  consequences
• Foster a greater emphasis on learning and
  adaptation as a generic response to uncertainty
• Engage managers, experts and civil society groups
  in comparison, discussion of strategies

50
Information Needed From Part 1

• Limits on confidence regarding what will be known
  about the rate of and extent of climate change
  over next 100 years for PNW and BC
• Implications for extreme weather events, average
  temperature, rainfall
• This will be input to mental model
  characterizations of experts regarding the
  implications of these uncertainties for
  particular kinds of resource management decisions

51
Values as crucial input

• We will use value-structuring methods to clarify
  what matters for important resource management
  decisions, in the views of a range of interested
  parties
• We can use the values to develop new, more widely
  supported strategies
• Values define information needed for assessment,
  evaluation

52
Information needed to foster more adaptive
resource management decisions

• For a given kind of decision (say, forestry
  response to pest infestations)
• When, where, how are decisions made now?
• Time scale of information collection, feedback,
  revising decisions, for key variables
• Role of analysis, discourse in current processes
• Incentives, penalties for adaptive approaches
• Institutional advantages and obstacles
• Fostering better decision processes

53
Adaptive Management and Decision Processes

• We have worked on ways to improve stakeholder
  decision processes for AM
• McDaniels and Gregory, Learning as an objective
  in structured risk management decision processes,
  EST, forthcoming.
• We are conducting a major project to design an AM
  plan for salmon aquaculture in BC, involving all
  stakeholders

54
Layers of Decisions

• Resource management decisions are often viewed on
  a site basis (for salmon fisheries, on a
  opening basis)
• The relationship between the narrowest level of
  decisions and broader decisions (say, at the area
  or regional level) is only starting to be
  explored in terms of approaches to management and
  regulation (McDaniels and Dowlatabadi, 2004)
• These layers of management decisions will be an
  important issue in design of adaptive strategies

55
Property Rights and First Nations

• In Canada, First Nations (native people) have
  been granted quasi property rights to be
  consulted about and share in benefits of resource
  harvests. In US, rights are more limited in some
  contexts, greater in others
• We can directly address issues of native
  involvement in fisheries decisions and IU due to
  our work with the BCAFC

56
Involving Managers, NGOs and Communities

• We will establish an advisory group from
  Washington and BC for this specific component
• Its purposes will be
• Advise on issues of scope and emphasis
• Help provide access to technical experts for
  mental models work, understanding key decisions
• Provide advice on key tradeoffs and strategy
  design from various perspectives
• Provide contacts for mechanisms to communicate
  our findings to interested parties

57
Synthesis Workshops

• We plan to hold decision synthesis workshops in
  the final years of the project involving a wide
  range of stakeholders
• Their purpose will be to characterize the results
  of our work, in terms of its design, process,
  findings, and the management strategies,
  potential consequences and tradeoffs
• We will seek preferences for alternatives,
  feedback on the issues and management practices
  involved and the chance to communicate broadly

58
Agenda(Cont.)
Part 2
1130-1145 Insurance managers - Daniel
Hoffmann and Granger Morgan 1145-1200 Questions
and Discussion 1200-1215 Forest, fisheries
and ecosystem managers in the Pacific Northwest
and Western Canada -Tim McDaniels 1215-1230 Qu
estions and Discussion 1230-1300 Lunch 1300-1
315 Arctic-region decision makers - Hadi
Dowlatabadi 1315-1400 Questions and Discussion
59
The Arctic Region
The challenge of reconciling rapidly evolving
environmental and social conditions with
management paradigms that emphasize restoration
of the natural state
60
(No Transcript)
61
Overview

• NADW is a key factor in determination of
  atmospheric and oceanic fluxes and sea-ice cover
  in the circumpolar region.
• These have defined
• the ecology
• the flow and fate of pollutants in the region,
  and
• The opportunities for resource exploitation.
• The local decision-makers have two classes of
  irreducible uncertainties to cope with
• The gross uncertainties in evolution of the NADW
  and its impacts on the flows that shape the
  arctic environment.
• The higher order uncertainties in interactions
  that these will precipitated within and across
  social and environmental processes.

62
Nunavut Government objectives

• Managing environmental conditions and
  biodiversity through good science and Inuit
  Qaujimanituqangit i.e. Traditional Ecological
  Knowledge.
• Building Healthy Communities.
• Ensuring the wise use of resources in a manner
  that will protect and enhance the environment now
  and for future generations.
• Developing and supporting sustainable economies.
• Provide the support needed for people to pursue
  sustainable livelihoods both in the traditional
  and wage economy.

63
Ocean Currents
Based on Macdonald, R.W. and J.M. Bewers, 1996.
Contaminants in the arctic marine environment
priorities for protection. ICES J. mar. Sci. 53
537-563.
64
Air Mass Flows
Based on mean air mass position Li, S.M., R.W.
Talbot, L.A. Barrie, R.C. Harriss, C.I. Davidson
and J.-L. Jaffrezo, 1993. Seasonal and
geographical variations of methane sulphanic acid
in the Arctic troposphere. Atmos. Environ. 27A
3011-3024.
65
NOx Emissions
Based on Benkovitz, C.M., T.M. Schultz, J.M.
Pacyna, L. Tarrason, J. Dignon, E.C. Voldner,
P.A. Spiro, A.L. Jernnifer and T.E. Graedel,
1995. Gridded inventories of anthropogenic
emissions of sulfur and nitrogen. J. geophys.
Res. 101 29239.
66
POPs in the Environment

• POPs are found in all compartments of the Arctic
  environment. The figure shows how these are
  partitioned in the bio-geo-chemical system and
  where bioaccumulation leads to human health.

67
IceCover

• Comparison of the averages of Arctic sea ice for
  the month of Sept. from 1973-1976 (left) to the
  averages for the month of Sept. from 1999-2002
  (right).
• Source NASA 2003.

68
Oil Gas
Source AMAP 1998. AMAP Assessment Report Arctic
Pollution Issues. Arctic Monitoring and
Assessment Programme (AMAP.
69
EthnicProfiles
Source AMAP 1998. AMAP Assessment Report Arctic
Pollution Issues.
70
Issues

• Environmental change
• Climate change, pollution flow and fate
• Economic viability
• Biological resources, mineral resources and new
  employment opportunities.
• Cultural identity
• Traditional Ecological Knowledge, population
  movements
• Politics
• Governance, International relations
• Health
• Traditional activity patterns and diet, desk jobs
  and imported foods
• Disasters and their management

71
A Long History of Seeking to Establish
Sustainable Communities
Yukon Alaska
72
(No Transcript)
73
Example of unknowns Impact of climate change on
drivers constraints
Drivers
Local Conditions
Constraints
Climate Change
74
Proposed Research

• Applied
• Developing indicators of the vitality and
  persistence of Arctic communities
• Assessing the importance of natural and
  introduced attractors in the long-term prosperity
  of communities.
• Helping local authorities design and implement
  adaptive management strategies that permit more
  rapid learning and response across Arctic
  communities. E.g.
• Support for traditional economy
• Support for infrastructure development and wage
  economy
• Theoretical
• Characterizing use by dates for knowledge (modern
  and traditional).
• Developing an algorithm for calculation of
  high-order interactions without enumeration.

75
Outreach and community involvement

• We will seek involvement from the expert and lay
  communities concerned with arctic development
  via
• Local research institutions
• Nunavut Research Institute
• Canada Climate Impact Adaptations Research
  Network (C-CAIRN) North
• Canadian Polar Commission
• DewLine to SeaLane project (MCRI proposal with
  Arctic Institute of North America).
• and partner communities
• Pangnirtung
• Cambridge Bay
• Bathurst Inlet

76
Agenda - Part 2(Cont.)
1300-1315 Arctic-region decision makers -
Hadi Dowlatabadi 1315-1400 Questions and
Discussion 1400-1420 Electric utility managers
facing capital investment decisions about
generation and 3P versus 4P - Paul Fischbeck
and Jay Apt 1420-1435 Questions and
Discussion 1435-1500 Break/Executive Session
77
Agenda - Part 2(Cont.)
1300-1315 Arctic-region decision makers -
Hadi Dowlatabadi 1315-1400 Questions and
Discussion 1400-1420 Electric utility managers
facing capital investment decisions about
generation and 3P versus 4P - Paul Fischbeck
and Jay Apt 1420-1435 Questions and
Discussion 1435-1500 Break/Executive Session
78
Why Electric Power?

• 250 billion annual sales
• Larger than telecom, computers, s/w, autos
• 3 trillion physical assets
• 4,700 generation units
• Over 3,000 Utilities in the US
• Enormous economic leverage
• August blackout 6 billion
• Enormous uncertainty in billion dollar decisions
  from incorporation of externalities

79
Power Plants
Beaver Valley
80
Power Generation Investments

• Large capital investments (750 M for 1 unit)
• Once committed, often expensive to modify
• Long lifetime 50 years
• Very large proportion of electricity cost (60)
• Critical factors
• Systems of different plants
• Environmental regulations
• Power market structure
• Uncertain financing
• Technology breakthroughs

81
Indirect Influence of Climate Change
Regulations
Perception of change
Changes in climate
Valuing externalities
Emissions control plant technology
Demand for power
Cost of power
Power market structure
Capital investment in power generation
82
Amplifiers of Uncertainty

• Perception of climate change
• Influenced by scientific understanding
• Complex combinations of stakeholders
• International, national, and regional pressures
• Conflicting goals
• Precautionary behavior and future generations
  or Job creation
• Regulations
• Political solutions to environmental problems
• Large uncertainties in predicting future
  regulations
• Not necessarily stable
• Criteria for upgrading coal power plants without
  adding emission controls changes with
  administration

83
Regulatory Uncertainty Timeline of Power Plant
Emission Regulation
emissions rate (lb./mmBtu)
State and Local smoke control laws, Federal
research
1977 CAAA
1990 CAAA
1970 CAAA
NOX
Acid Rain Group 2
NSPS
OTC NOX Budget
Hg
A. R. Group 1
Acid Rain
BACT/LAER
RACT
SO2
NOX SIP CALL
BACT/LAER
NSPS
Typical uncontrolled emissions rates
NSPS
MACT
1990
1965
1970
1975
1980
1985
1995
2000
2005
2010
84
The Future is Not Clear
Kerry 2008?
Note EPA may have authority and intent to impose
Jeffords-like limits, but may have to use rigid
command-and-control policies to do so.
Sources EPA, White House
85
Traditional 3P Emissions Control Technologies

• SO2
• Fuel switch (away from high sulfur coal)
• Flue gas desulfurization (several different
  kinds)
• NOX
• Combustion LNB, OFA, Lean Burn
• Post-combustion SNCR, SCR
• Mercury (Hg)
• Fuel switching (coal) and coal cleaning limited
• Traditional technologies have uncertain effects
• FF, FGD, and SCR are effective at removing
  various forms of Hg
• Hg-specific control technologies
• Sorbent injection and capture.
• FGD enhancements (SCRFGD ?)
• Final disposal of Hg-containing ash or sorbent
• Carnegie Mellons Center for Energy and
  Environmental Studies (CEES) has developed
  relevant performance and cost models (ICEM).

86
Utility Managers and CO2

• Granger Morgan asked two audiences of utility
  executives, How many do not believe the US will
  have significant carbon regulation by 2020? Only
  one hand went up at the 2002 EPRI workshop and
  four at a 250-person meeting at Alliant Energy.
• EPRIs Board then charged EPRI with developing a
  new strategic plan related to climate change.
• The CEOs of Cinergy, Excelon, and Alliant all are
  on record as believing carbon caps are
  inevitable. They do not know how to approach
  investment with this uncertainty.

87
CO2 Control Technologies

• Conservation, efficiency and renewables
• Traditional emission controls reduce efficiency
• Low-carbon fossil fuels (e.g., natural gas)
• What price? Sufficient? Imports?
• Carbon sinks
• Sufficient? How permanent?
• Carbon capture and sequestration (CCS)
• What price? How acceptable?
• Geo-engineering
• How feasible? How acceptable?

88
The Big Questions About 3P/4P

• What are effects of timing, level, and forms of
  regulation?
• How to balance costs and benefits?
• How to induce sufficient technological innovation
  to meet the goals at lowest social dislocation?
• How to keep the existing, coal-fired power plants
  available to produce low-cost power?
• What sort of power plants (using what sort of
  fuels) to invest in for the future?

Bottomline Uncertainty about future regulations
can have measurable costs for power generation
owners/operators
89
Risk

• Risk is the set of triplets R (si, pi, xi)
• si What can happen?
• pi How likely is it to happen?
• xi If it does happen, what are the
  consequences?
• For short-term decisions, all three can be
  assessed with confidence.
• For long-term decisions, confidence that the set
  of scenarios is exhaustive disappears.
• But, it is still possible to make predictions
  about the distribution of consequences.
• Limiting factors caused by physical/economic
  properties
• Long-term averaging because of mean-regressing
  processes

90
Scenarios in Power Generation Modeling

• Scenarios are the typical way that future
  uncertainties are modeled out to 25 or 50 years
• A set of deterministic forecasts (5-10) is
  created to span the variable space
• Solutions for each scenario are determined
• Robustness claims are inferred
• Limitations
• Are the scenarios a representative set?
• Are the scenarios equally likely?
• How much uncertainty is there within each
  scenario?
• How can they be used to support decisions?

91
Industry Typically Makes Strategic Decisions via
Scenarios

• Specify a few futures, with deterministic values
  for fuel, NOx price, interest rate, etc.

With full recognition of the underlying
uncertainties, the decision surface can be
understood.
92
Two Research Questions

1. How will different climate change estimates and
   their associated uncertainties influence
   perceptions and in turn, regulations?
2. Given the uncertainty of future regulations, what
   is the impact on decision making for power
   generation assets?

93
Evolving Regulations and Standards

• Database of approximately 250 regulations over 40
  years dealing with transportation fuels
• Research conducted in the Center for the Study
  and Improvement of Regulation (CSIR) by David
  Stikkers
• Evolution of standards over time
• Within a regulation (between proposed to final)
• Between regulations (challenged, revised,
  updated/follow-on)
• Initiating/motivating events
• Influence of stakeholders
• Impact of uncertainty
• Preliminary stringency results
• Reduced during regulation making
• Increased between regulations
• Varies with amount of uncertainty
• Decreases lead to challenges

94
Important Questions

• As climate change predictions evolve, what
  happens to the ensuing regulations?
• What combination of evidence would lead to
  precautionary regulations?
• Reject guaranteed short-term gains to prevent
  unlikely long-term losses
• Related to other ongoing studies
• What type of climate change predictions would
  cause a tightening/relaxation of regulations?
• Leaded gasoline (its worst than previous
  thought)
• MTBE (requirement, ultimate need for, clean-up)
• Can the same set of predictions lead to very
  different regulations?
• Influence of other factors (election results)
• How is this uncertainty modeled?
• How are investment decisions made given this
  uncertainty

95
Expert Elicitation Protocol

• Experts
• Utility executives
• Regulators
• Conditional on the results from Part 1 (given a
  climate change forecast), quantify the
  distributions of the resulting regulations
• Timing (immediate to delayed)
• Stringency (none to high)
• Technology (performance-based to prescriptive)
• Protocol based on Morgan and Keith
• Capturing uncertainties
• Use of scenarios to expand thinking
• Relying on significant existing contacts in CEIC
  and CSIR

96
Valuing Generation Assets Given Uncertainty

• Different levels of analysis are possible
• Deterministic Suppose you know everything
• Game theory Multiple decision makers
• Monte Carlo Adding uncertainties
• Portfolio Assets cannot be valued in isolation
• Real options Determining the value of creating
  future decisions
• Each provides some level of insight, but without
  a system-level framing that includes uncertainty,
  analyses can lead to valuation errors

97
Deterministic AnalysisOptimal Configuration by
Scenario

• Scenarios well defined (allowance and fuel costs,
  caps)
• Lists of possible control configurations for each
  plant
• Find the configuration that works best with a
  scenario

98
Dominant Strategy Regret Table
Going with the dominant optimal configuration
for each plant will provide relatively good
results in 4 out of 7 scenarios
99
Appreciating the Importance of Uncertainty
through Sensitivity
One unit under one scenario
Practical outreach this convinced the utility
that adding uncertainty to scenario analysis was
both do-able and important!
100
Adding the Uncertainty

• Missing key pieces of knowledge.
• Which pollutants will be controlled?
• When will the controls be required?
• At what level will the limits be set?
• What type of regulatory instruments will be used?
• Plant owners cannot wait for all uncertainty to
  be resolved before making investment decisions.
• A strategy that is optimal under one regulatory
  scenario could be very expensive under others.
• Lack of regulatory knowledge can be expensive.
• Improving knowledge about future regulations can
  have economic savings for the plant operator and
  the industry.
• How robust are certain choices?
• May be being wrong doesnt cost that much.

101
Multi-period Decision Model

• Scenarios and belief in them evolve over time.
• Even as some uncertainty is resolved, new
  questions arise
• It takes time to install a new technology.
• Belief about future regulations evolves in
  different ways
• Informed/Uninformed/Mistaken
• Decision maker has to decide when to take action.
• Decision is dependent on
• Belief in the likelihood of the various scenarios
  
• Scenario-specific values (reductions, allowance
  costs, fuel prices)
• Configuration parameters (capital costs, heat
  rate, OM)
• If the decision maker waits until correct
  scenario is revealed, then benefits are delayed.

102
Optimal Configurations
Given a final correct scenario and a knowledge
evolution, what configuration will minimize
expected NPV costs?
Knowledge evolution makes a difference. With less
informed forecasts of the future, unnecessary
equipment is installed and/or timing is off.
103
Portfolio Analysis

• The value of generation assets vary based on
  whats happening in the market
• Changes in fuel prices/demand
• Specifics of regulations
• Location on the grid
• The value of some plants would change in very
  similar ways while others would not
• A sulfur regulation would negatively affect the
  value of a coal plant and positively affect the
  value of a gas plant
• The fact that plant values are not perfectly
  correlated allows investors to reduce their risk
  by using techniques from economic portfolio
  theory
• We have developed techniques for incorporating
  the complexity of the power grid and
  distributions of future key factors to display
  power generation assets in a risk-return space.

104
DMUU and Portfolios

• By combining assets, investments on the
  efficient frontier can be found
• This can be done at generation-technology scale
  or an individual plant scale
• The value of adding an asset varies based on what
  is in the portfolio

105
Effects of Climate/regulatory Uncertainty

• If, because of climate/regulatory uncertainty, we
  dont know precisely the expected future return
  and standard deviation of an asset, then it
  follows that the efficient frontier must actually
  be a distribution of frontiers and there is,
  similarly, a distribution of optimal portfolios
• What is the impact on portfolio value?

106
The Environmental FrontierPortfolio
Optimization and 3PCO2

• Until now, the criteria have been exclusively
  finance-oriented
• However, portfolios can be constructed to satisfy
  any number of criteria
• The Regulators Perspective Emissions in the
  objective function
• Minimize emissions such that risk and return are
  within acceptable parameters
• The Firms Perspective Emissions in the
  constraints
• Maximize Sharpe ratio such that emissions do not
  exceed a certain level
• The Consumers Perspective
• Minimize total expenditures such that reserve
  margin levels are sufficient to prevent service
  interruptions

107
Trading Credits and Expanding the Efficient
Frontier

• In the basic model, all assets are power plants
• Suppose new assets emissions credits are
  introduced
• The introduction of these assets into the
  feasible set Pareto-improves market participants
• In our model, this can be seen directly by noting
  that the efficient environmental frontier expands
  northwest
• More efficient combinations of assets are
  possible
• On a regional level, the dollar size of the
  Pareto gain can be quantified

108
Initial Center Tasks

• Develop a protocol for assessing from experts the
  impact of climate uncertainty on future
  regulations
• Will be directly tied to results from Part 1
• Will allow investigation of the effects of
  improved understanding (reduce uncertainty) of
  climate uncertainty
• Develop portfolio-level models that will permit
  an economic analysis of climate-induced
  regulatory uncertainty.
• Include probability distribution functions for
  generation plant parameters, economic dispatch,
  and non-deterministic frontier
• With this framework
• Quantify the cost of regulatory uncertainty and
  regulatory predictability
• Evaluate risk-mitigation programs
• Use feedback from real-world decision makers to
  develop decision support tools.

109
Outreach

• We will communicate our results and seek input
  and involvement from the electric power community
  via
• Annual presentations to the EPRI RAC.
• Annual reports to the CEIC and CSIR advisory
  boards.
• Using CEIC and CSIR contacts, provide detailed
  briefings and research collaborations with
  individual utilities.
• Periodic briefings to PUC commissioners via the
  EPRI Advisory Board.
• Presentations to NGOs (e.g. CECA), political
  leaders, FERC.
• Underlying structure of the research is directly
  relevant for other large-scale industries that
  would be affected by climate-related regulations
  (e.g., petro-chemical and automotive
  manufacturers).
• Using CSIR contacts, provide briefing to other
  industries