Saving The Environment

The other day I was chatting to a very experienced City fund manager, and we got on to the subject of all those companies that have sprung up in the last few years with various plans and products to clean up the environment, to save fuel, recycle waste and generally save the planet.

‘Of course,’ he said, ‘we all know it is going go to end in tears.’

He was not referring to some grim and tragic end to the planet. He was referring to the fate of this burgeoning sector of the market, which exhibits some of the characteristics of the dot-com sector of 2000.

Investors transfixed by a clever idea, and overlooking the necessity for profits in their excitement at the prospects for growth. No doubt many of these new ventures will fail although I also have no doubt that there will be a few spectacular winners. But one of the problems with the whole environmental debate is that it is a great deal more complicated than it seems. In the April edition of my newsletter Red Hot Penny Shares I described the debate surrounding plastic bags and why experts who have studied the problem in depth have concluded that this indestructible item of waste does in fact do much less damage to the environment than any of the alternatives – the paper bag for example. Now we hear that the experts are changing their minds about biofuels.

This was the subject of the Gallagher Review, which came out last week, and concluded that the rush to promote biofuel – essentially fuel made from crops – is perhaps not such a good idea after all.

It gives a few reasons that may seem obvious but clearly never occurred to policy makers when, in their anxiety to display their green credentials, they encouraged the use of biofuels. Specifically the EU proposed that biofuels account for 10% of energy consumption by 2020, but the Gallagher Review makes it clear that the side effects of such a rush into biofuels could do more harm than good.

Gallagher has advised, and the UK Government has accepted, a reduction in the targeted use of biofuels, citing a number of factors. Principal amongst these are that the land on which biofuel crops are being grown could otherwise be used to grow food crops; that biofuels only contribute towards greenhouse gas savings ‘if significant emissions from land-use change are avoided and appropriate production technologies are employed’; that areas of carbon-absorbing forest are being destroyed to make room for biofuel crops; and that increasing demand for biofuels can raise the price for commodities such as oil seeds to the detriment of the poor.

Didn’t anyone think about it?

What seems surprising is that these side effects were never considered before. Gallagher makes it clear that policy formulation in support of biofuels has been inadequate. ‘Current lifecycle analyses of greenhouse gas effects fail to take account of indirect land-use change and avoided land use from co-products.’ ‘Urgent further work,’ it adds, ‘is needed to enable incentives and targets for biofuels to be based upon lifecycle greenhouse gas emissions.’ This all begs two questions. Should governments try to interfere in the free market? And if so, are they capable of doing the type of exhaustive cost-benefit analysis that is required?

In the matter of climate change the argument is that individuals and businesses are all far too focussed on short term gratification to take care of the needs of future generations. So governments believe they must take action. But in fact the combination of the free market allied to a change in individual preferences based upon information and knowledge will probably do far more to alter habits in respect of the environment than prescriptive government policies.

So far as cost-benefit analysis is concerned speak to any businessman who is trying to sell a new product into the public sector, backed by evidence that although it may cost more up front it will actually save money over time, and they will tell you that public servants are rarely able to look beyond the upfront cost.

If this is true of labour saving software programs or hospital bed-saving new medicines what hope is there that Governments can adequately assess the real costs and benefits of environmental proposals, where the chain of cause and effect is hugely more complicated?

Government should be very careful in is area. As Gallagher point out the EU agreed to give generous subsidies for the production of biofuel crops back in 2003 ‘against a backdrop of grain mountains and payments to farmers for set-aside land.’

Both of those are prime evidence of the folly of interfering in the free market, and the shocking misallocation of resources that can result. The rush for biofuels has the making of another such instance. Hopefully Gallagher’s welcome review will prompt a rethink. If you enjoyed this article then sign up for Red Hot Penny Shares. Its aim is simple: to lead you straight to the undiscovered, unloved, under-priced small cap shares destined to become the big boys of the future…

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Saving The Environment

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