Tuesday, January 12, 2010

Risk Management and Global Warming, Part 2

In last week’s installment, I laid out a risk management approach as it applied to global warming.

In summary, a risk is some event (threat or opportunity) that has a probability of happening, and has an impact if it does happen. The value of the risk is the probability times the impact (R=PxI). Compare the value of the risk to what it would cost to shrink it or make it go away. Sometimes it’s cheaper to deal with the risk, sometimes it’s cheaper to accept it.

When it comes to global warming, most of us have some doubt. To have an educated opinion about something, you need an education. I’m not a climate scientist, nor do I play one on TV. Any opinion I have on the subject has to be tinged with uncertainty.

But risk is all about uncertainty.

More About Probability

The sum of all the probabilities of the possible outcomes is one, or 100%.

  • What’s the chance of flipping heads or tails on a coin? 100%. (Yes, I’m neglecting the possibility it lands on the edge.)
  • What’s the chance of rolling a 1, 2, 3, 4, 5, or 6 on a six-sided die? Well, 100%.
  • What’s the chance that the effect of any global warming turns out to be either positive, nothing, minor, moderate, serious, or catastrophic? ______%
Oh, let’s not always see the same hands.

What's Your Risk Number?

If you’re not persuaded by the science, if you’re unsure what level of action — if any — is prudent, here’s how to calculate your own risk value. That gives you a financial base to work from in evaluating proposed responses.

Let me be clear up front — this is an extremely simple model that leaves out or abstracts hundreds of important considerations. (I'm open to suggestions.) This model has one purpose: to provide a number that has enough meaning to help you compare the cost of potential solutions to the cost of accepting whatever risk you may think is present.

The number also helps compare where you are in comparison to someone else, which can help bring clarity to a discussion. If person A thinks the risk should be valued at $25 billion tops, and person B thinks a conservative valuation of the risk is more like $5 trillion, then we know something about how each person sees the world.

The common ground in any argument is always and necessarily the lowest number on the table. In the discussion above, the common ground is any response to the risk that costs less than $25 billion. (A lot of people who oppose action support continued study, which is certainly part of the family of legitimate risk responses.)

Download the Spreadsheet

I've developed a spreadsheet that does this automatically for you. The link is below. Just click to download the Excel file to your desktop.

Click here to download my Global Warming Risk Calculator spreadsheet. (Permission is given to distribute it freely; in fact, please do.)

Using the Global Warming Risk Calculator

To perform this exercise, you have to divide 100% (the sum total of all the possible outcomes) among the following categories, based on how likely you think each outcome is. I’ve put down a potential cost number for each outcome; feel free to change the number if you evaluate the impact differently. And, while you’re at it, if you think there should be more outcome categories, add those too. But you still can only divide a total of 100% among them.

For purposes of illustration, I’ve added in my own personal probability guesses. As you can see, I’m not exactly a died-in-the-wool true believer.
  • Positive. Climate change is a net benefit for the world. (Economic impact: -$1 trillion — save or make money) (My guess: 0.9%, with a leftover .01% chance for Very Positive, -$10 trillion)
  • Nothing happens. (Economic impact: $0) (My guess: 32%)
  • Minor. There are some spotty problems, but they’re manageable. (Economic impact: $1 trillion) (My guess: 30%)
  • Moderate. There are significant increase in major weather catastrophes; regional crises more common. (Economic impact: $5 trillion) (My guess: 30%)
  • Serious. Global warming impact becomes the dominant geopolitical issues of the time. (Economic impact: $10 trillion) (My guess: 5%)
  • Catastrophic. There are massive die-offs, huge geographic dislocations, and major coastal flooding. (Economic impact: $25 trillion) (My guess: 2.9%, with the remaining 0.1% for the $100 trillion life-as-we-know-it-is-over jackpot.)
The next step is to calculate the expected monetary value (EMV) of the risk. That’s the PxI for each of the steps above.
  • Positive (= 0.9% x -$1 trillion, plus 0.1% x -$10 trillion)
  • Nothing (= 32% x $0)
  • Minor (= 30% x $1 trillion)
  • Moderate (= 30% x $5 trillion)
  • Serious (= 5% x $10 trillion)
  • Catastrophic (= 1.9% x $25 trillion, plus 0.1% x $100 trillion)
Add those answers together, and that’s how much money I think the risk is worth. When you plug in your numbers, you’ll get your valuation of risk.

On the second page of the spreadsheet, you'll see a UN-prepared chart on the cost of reducing carbon emissions by 2050 to achieve various targets. I've turned those GDP percentages into actual dollars, then converted those back to 2010 present value numbers.

The spreadsheet will automatically compare your valuation of the risk against the various UN targets, and tell you whether according to your own risk assessment whether the cost is too much or worth considering.

Try It Yourself!

I’ll wait.


How did you value the risk? Please post it as a comment. I'd love to know what you think.

Now What?

What, in your opinion, does that number suggest to you?

My global warming risk number is $2.86 trillion, and as you can see I’m not a passionate believer in imminent global catastrophe. That’s quite a bit of money; I was a little surprised at the answer when I did the math. (As my friend Misha pointed out in his comment on the previous installment, with that much money, at least some should surely be spent on mitigating secondary impact, as costs often fall heavier on the poor.)

Comparing that number to the cost of stabilizing CO2 emissions, it looks like I'm in favor of action, though that 450 ppm target is a close thing. But for 550 ppm, the numbers look good to me.

Obviously, I’d just as soon we don’t spend all that money unless we really have to. It’s always okay to spend less if that solves the problem. But with that much at stake, it seems to me that prudence argues for at least some significant action.

It also argues for continued research and refinement. Those probability and impact assessments won’t stay static. They may get worse, or they may get better.

And as they change, so too should our own opinions and beliefs.

And In The End...

I'm neither expecting to nor intending to change anyone's opinion on this question. I'm simply looking for common ground and a different way to frame this intractable issue.

What's your number? I'd really like to know

No comments:

Post a Comment