Caution! Net zero scenarios are not forecasts

Why the blurring of the normative and the predictive is leading to a misallocation of capital

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Back in 2017, I wrote a book about the perils involved with forecasting commodity prices, and how to spot the underlying incentives guiding those who proffer such predictions. My book, Crude Forecasts: Predictions, Pundits & Profits in the Commodity Casino outlines how to become a smarter consumer of forecasts and avoid getting suckered into the compelling narratives spun by think tanks, investment banks and market pundits. I suggest that rather than forecast, it’s much better for companies involved with commodities to scenario plan instead:

“…scenario planning involves sketching out different possibilities and bringing together people with different perspectives to work through the details. The end result should be several plausible, internally consistent and emotionally compelling stories about the future. The scenarios will highlight hidden connections and make distant consequences seem real. Importantly, though, the scenarios should also contradict each other.

Since scenarios are persuasive stories, they can help us face up to uncomfortable prospects and think clearly about possibilities we would rather ignore. And because scenarios contradict each other, they force us to acknowledge that, in the end, we cannot actually see into the future. As a result, we move from a sterile question to a fertile one – from “What will happen?” to “What will we do if it does?”

The danger, as I outline in the book, is that once out in the public domain, scenarios are very easily misinterpreted as being a forecast. In mid-2017, it was the International Energy Agency (IEA) that was on the hook as analysts poked fun at the organisations poor record at predicting photovoltaic (PV) capacity. If they had been so slow to forecast PV capacity growth, so the argument went, then they could also be underestimating the growth in electric vehicles. Here’s the IEA’s response to its critics (emphasis added my own):

“The projections in the New Policies Scenario signal to policy-makers and other stakeholders the direction in which today’s policy ambitions are likely to take the energy sector. This does not, however, make this scenario a forecast – a point that needs constantly to be kept in mind.”

It’s very easy to slip into making decisions about the future based on what we wish to happen, especially if that happens to coincide with the commonly accepted narrative. Take the IEA’s Net Zero scenario as an example. It’s treated by many to be the gospel as to where the world will be in 2050.

Acting on predictive analysis that conflicts with that normative perspective is psychologically disconcerting, but that’s the position many companies find themselves in as they look to invest capital over the next 2-3 decades.

Rather than force carbon intensive businesses to wrestle with conflicting versions of the future, the risk is that companies succumb to stasis. Sitting on their hands and muddling through, rather than taking an assertive position.

Let’s consider an example.

Fossil fuels producers typically get all the attention when it comes to tackling GHG emissions and getting to net zero. Investors are naturally fearful that climate policies, and the energy transition more broadly, will mean that oil, gas, and coal producing assets could become ‘stranded’.

However, it’s worth remembering that there is a whole supply chain that supports the trade in oil, natural gas, and thermal coal. Tens of thousands of crude and product tankers, dry bulk ships, and LNG vessels criss-cross the globe. The shipping industry plays a vital role in ensuring these commodities can be transformed across space, time and form so that supply meets demand.

The shipping industry contributes to climate change, but its future is a function of the production decisions taken by fossil fuel producers and mining companies decades into the future.

Could net zero scenarios lead them astray? Let’s dive in.