Virtually Certain Long, Short, and Volatility Trades

Most investors would love to have certainty on future events, especially those that can be measured and monitored. Historically, financial engineers have found ways to create investment vehicles to monetize such high conviction events. I have heard such investments being called “no brainers”. Today I will introduce a few such “no brainers” based on high conviction scientific research. I will also share with you why traditional investors are finding it hard to invest in these. Lastly, I will conclude this month’s Arcus by outlining how we at Panarchy are approaching these “no brainer” opportunities.



Source: ANU

IPCC Assessment Report 6 – Finally, No Brainer Facts.


Human activity is causing global warming, climate change and frequent extreme weather.

  1. Climate change is accelerating. As an example, recent rate of warming is unprecedented in the last 2,000 years, and we are seeing the fastest rate of sea level rising in 3,000 years.

  2. Climate change is affecting every region.

  3. Aerosol (pollution) cooling is masking the actual global warming and Net Zero at global scale is the only solution to global warming.

Since 2018, 234 scientists from 64 countries have reviewed over 14,000 scientific articles, requiring 78,000 comments to be answered by the authors. The result being “Climate Change 2021: The Physical Science Basis” which was released early August. This is the 1st of what will be 4 reports (released in the next 12 months) that will shape how we all tackle the now indisputablehuman created global warming and climate change.


As a reminder this is the 6th assessment cycle by IPCC, with the 1st starting in 1988. Sadly, the headline chart above shows that since the 1st Assessment in 1990 we have already added 1trn tons of CO2 into our environment, despite being told of its potential impact, a no brainer act I would say.


“Just Imagine… Over the last 30 years we have emitted a 12.3-foot-high blanket of carbon dioxide over the earth’s land surface. Every year we add another half a foot to that blanket.” Panarchy Partners

Good and Bad News As an optimist let me start with the good news. There is still some hope that we can slowdown if not stop what seems like a disastrous future for our coming generations. A global Net Zero carbon reality by mid-century (very low CO2 scenario below) will only see us temporarily overshoot the +1.5-degree above 1850’s industrial levels target set in Paris in 2015. For us to achieve a 2040 net zero target, we need to reduce emissions by ~5% of today’s levels every year till 2040.


Source: IPCC 2021, AR 6.

The bad news is that climate change is accelerating faster than ever before and in all the 5 scenarios of carbon emission paths we can take in this report, (even the very ambitious one shown above) we will go past the +1.5 degree target. Most climate changes are irreversible in our lifetime, but we can slow down the damage. As the table below shows, we can only sustain today’s levels of carbon emissions for 8-12 years before we reach the +1.5 degree threshold, and 23 years to get to +2 degree, thus making it even harder if not impossible for future generations to correct the problem.


Carbon Budget Limits


Source: IPCC 2021, AR 6.


Sadly only 110 of 191 parties to Paris Agreement have submitted new Nationally Determined Contributions (NDCs) to carbon emission ahead of COP26 & the promises made so far from countries if delivered will limit warming to +2.1 degrees by end of the century. Not good enough! Today I will not touch upon the why and how of getting to Net Zero, as future IPCC reports by working group 2 and 3 (2022) will cover mitigation and abatement measures. So, coming back to the trends and events predicted in this IPCC report, “Climate Change 2021: The Physical Science Basis” which will not only impact us but can also drive our decisions as Panvestors. High Conviction Trades This latest IPCC report is by far the most convicted with near airtight scientific conclusions. The report has used the following terms to indicate the probability of an event occurring. Below I have also highlighted the number of times a specific probability classification has been used in this 12-chapter, 4,000-page report.

  • Virtually certain (99%-100% probability) – 464 times

  • Extremely likely (95%-100%) – 206 times

  • Very likely (90-100%) – 986 times

  • Likely (66%-100%) – 1,187 times

  • Unlikely (0-33%) - 37

  • Very unlikely (0-10%) – 27

  • Extremely unlikely (0-5%) – 17

As you can see the report is full of high conviction predictions with less time spent on unlikely but shocking outliers that in the past would have been used to get various stakeholders and policy makers attention. Using the report’s probability classifications above, here are some virtually certain (99%-100% probability) ideas investors will no doubt like to act on. Long Trades It is virtually certain:

  • That atmospheric CO2 and oceanic pH will increase in all climate scenarios

  • Land surface will continue to warm more than the ocean surface

  • That the number of hot days and hot nights and the length, frequency, and/or intensity of heat waves compared to 1995-2014 will increase over most land areas

  • That the Arctic will continue to warm more than global surface temperature, with high confidence above two times the rate of global warming

  • That global mean sea level (GMSL) will continue to rise

  • That ocean warming will continue over the 21st century & upper ocean stratification, ocean acidification will continue to increase

Volatility Trades It is virtually certain:

  • That there will be more frequent hot extremes and fewer cold extremes at the global scale

  • That global water cycle intensity, considered in terms mean precipitation, evaporation, and runoff, will increase

Source: IPCC 2021, AR 6.

Shorting Trades

It is virtually certain:

  • That there will be reductions of Northern Hemisphere snow cover, in terms of water equivalent, extent and annual duration

  • That projected warming will result in continued loss in Arctic Sea ice in summer, especially the Greenland Ice Sheet

  • That glaciers will shrink in the future

September Arctic Sea Ice Area



Virtually Certain Events ≠ No Brainer Trades


No doubt there are ways that people can invest with the above virtually certainevents in mind. Some may find Arctic summer cruises as a growth industry, while others might feel snow making machines in North America have a bright future, but these investments have limited scale and are arguably opportunistic rather than positively impactful.


Another obstacle in implementing these predictions into investments is that most investors will find the timing of the above events outside their employment horizon and the pace of change too slow to deliver benchmark beating financial returns for their next bonus cycle.


For those investors wanting to prevent the above events from happening there is a technology challenge as well. Lack of understanding of the technology that will help slowdown, if not stop the above events from happening needs to be dealt with. Climate change mitigation and adaptation technological advancements are gathering pace but are still at a very small scale and are unprofitable.


The last and biggest challenge for implementing these no brainer trades is regulations and policies. How quickly do the AR6 report’s findings get converted into global consensus and then implemented through regulations at regional and local levels? While CO2 emission regulations are gaining pace globally, the top-down policies need to find bottom-up regulations for various industries and sectors. With 120 countries having committed to Net Zero CO2 emission targets, their polices will now need regulations to deliver. Only through such regulations will the science shown above find commercial solutions that investors can invest in.



Panarchy's Approach


We know that the purpose of this IPCC Working Group 1 report is to arm policy makers in governments with enough and relevant data. Now that global warming and climate change has a universal consensus, the science has also been fine tuned to the point that policy makers will find this report very instructive.


There are two levels at which we review policies and regulations.


The first is at a regional level. Let us take Australia as an example, where AR6 and its associated interactive Atlas provides the following predictions to Australian policy makers:

  • It is virtually certain that more frequent hot extremes and heatwaves are expected over the 21st century in Australia,

  • It is virtually certain that relative sea-level rise will continue around Australasia, contributing to increased coastal flooding in low-lying areas,

  • There is high confidence that there will be significant decrease in April to October rainfall in southwest Western Australia,

  • In the future, heavy precipitation and pluvial flooding are very likely to increase over northern Australia and central Australia

Armed with the above scientific facts there is no reason why policy makers in Australia will not start regulating specific industries and sectors. The potential for targeted regulations creates not only risks to our portfolio companies but also opportunities.


The second and more investable approach we are taking is to identify regulations that are changing industries and sectors, thus determining global winners and losers. There is already a history of climate policies becoming regulations with investable outcomes. As an example, the 2016 Kigali Amendment to the Montreal Protocol has inspired regional laws on refrigerants in cooling systems. Globally laws are forcing out high global warming potential (GWP) HFCs (hydrofluorocarbons) and HCFCs (hydrochlorofluorocarbons) and replacing them with natural refrigerants like HFOs (hydrofluoroolefins). In the US between January 2020 and January 2024, various HFCs will be banned in commercial HVAC. This creates a risk and opportunity for our portfolio company Trane Technologies.


Knowing how climate inspired and IPCC AR6 backed policies and regional laws will evolve in the coming decades will become a crucial skill every investor will need. At Panarchy Partners we have a disciplined research framework that should help us navigate this climate challenge by identifying investable opportunities.


Conclusion


IPCC AR6 Working Group 1 report is just the start of what will be a very important 12 months for the world’s climate change approach going forward. As this report was approved by almost all countries in IPCC, we hope the scientific facts in it will empower COP26 (Glasgow, November 2021) and lead to an even more firm commitment than what we found in Paris in 2015. After COP26, we look forward to Working Group 2 and 3 reports on Impact & Adaptation and Mitigation of Climate Change as they should provide more investable ideas as well.



Happy Panvesting

Munib