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The Supreme Court's Own Goal on Climate Change

[This article appeared in Lawfare. It's long for a musing, but I think it's important that the public see just how shoddy was the majority reasoning in West Virginia v EPA]

In 1970, Sen. Roman Hruska of Nebraska achieved a dubious immortality when he argued that mediocrity deser...

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The Supreme Court's Own Goal on Climate Change


Monday August 08, 2022

[This article appeared in Lawfare. It's long for a musing, but I think it's important that the public see just how shoddy was the majority reasoning in West Virginia v EPA]

In 1970, Sen. Roman Hruska of Nebraska achieved a dubious immortality when he argued that mediocrity deserves “a little representation” on the Supreme Court in remarks supporting the failed nomination of G. Harrold Carswell. Were he alive today, Hruska could say, “Mission accomplished.” A reading of the Court’s opinion in West Virginia v. Environmental Protection Agency (EPA) in June provides abundant evidence of ignorance, bad faith, and, yes, mediocrity in the arguments presented in limiting the EPA’s authority. Despite all that, thanks to a sea change in the economy, the Court’s decision may have only a minor impact on efforts to reduce greenhouse gas emissions in the United States. It could, however, hurt international efforts to coordinate action on climate change.

To begin with, as noted in Justice Elena Kagan’s acid dissent, the Court chose to shove a phantom issue into its crowded docket. The Clean Power Plan, the Obama-era climate policy aimed at lowering emissions by 32 percent by 2030 that is at the center of the case, was not in effect and was not intended to go into effect as currently constituted. Worse, by limiting the EPA’s authority to regulate how power is generated in order to meet carbon reduction goals, the majority cites outdated, easily falsifiable costs were the plan to have gone into effect. 

Further, there is no expression of concern about the economic and societal effects of climate change, which include trillions of dollars in damage to the global economy, forced migration as people flee regions that become unlivable, and the potential for civil unrest and mass starvation. Nowhere in the majority opinion can one find stipulation that climate change is “the greatest environmental challenge of our time,” as Kagan describes it. 

The majority’s nonchalance stands in jarring contrast to the posture taken by most of the world’s governments, the global scientific community, the executive branch of the U.S. government, and even the otherwise polarized and paralyzed Congress. Last week, the Senate came to agreement on providing $369 billion in tax credits and other incentives for companies and homeowners in order to drastically lower U.S. emissions by 2030. This came as a surprise to many observers after Sen. Joe Manchin (D-W.Va.) said last month that he would not support a climate bill until inflation was addressed. But Manchin appears to have changed his view and made a deal with Senate Majority Leader Chuck Schumer (D-N.Y.). If passed, this would be the most ambitious agreement taken by the U.S. in the fight against climate change. For its part, the executive branch is also taking the climate crisis seriously, with President Biden announcing last year that he intended to cut U.S. emissions 50 percent below 2005 levels by 2030. In July, Biden presented new executive actions on protecting communities from extreme heat, lowering cooling costs for those same communities, and expanding offshore wind jobs.

Many other government agencies have taken the climate crisis seriously for decades in their own capacities. The U.S. Defense Department and various intelligence agencies have treated climate change as a threat to national security going back to the 1990s. A review of the literature reveals dozens of studies, white papers, and other publications linking climate change and national security. The majority opinion of the Supreme Court, however, suggests that the most august court in the land remains oblivious to this threat. The only references to the costs of climate change in the majority opinion are indirect, in the form of citations of the concerns of the EPA and other groups. By contrast, in her dissent, Kagan devotes the first two paragraphs to the various costs of climate change and cites the 2021 Climate Risk Analysis 8 from the Defense Department that warns that the ultimate risk might be “state failure.”

Given 34 years of a drum beat of news on global warming, it is inconceivable that the justices in the majority are ignorant of the threat. In recent years, all the justices had to do was look out the window or turn on the news, as the country has been besieged with record heat, wildfires, and floods, all tied to climate change. Is it possible then that the majority opinion and concurrence avoided any recognition of the scale of the threat because doing so would make the case that regulatory authority could help to avert it? 

The fight over the Clean Power Plan and the EPA’s regulatory authority has a tortured history. The Clean Power Plan originated in the final years of the Obama administration and was stayed by lawsuits until President Trump (who could utter the phrase “beautiful clean coal” with a straight face) came into power and his fossil-fuel-friendly EPA tried to kill it altogether and replace it with a far weaker plan called the Affordable Clean Energy rule (ACE). This plan, unlike the Clean Power Plan, didn’t require power generators to switch fuels to achieve emissions reductions. The ensuing outcry produced a flurry of lawsuits that prevented ACE from coming into force. When Biden took office, his EPA asked the Court of Appeals to stay its reinstatement of the Clean Power Plan while it considered whether to change the rule in Section 111(d) of the Clean Air Act, which directs the development of emissions standards for pollutants arising from existing sources. The EPA used this rule to justify its mandate to force coal-fired plants to shift fuel sources in order to meet emissions reduction goals. All of this remained in legal limbo until the Supreme Court decided to enter the fray under the reasoning that the EPA could, at some point in the future, insist on shifting fuels away from coal.

In making their argument, the majority takes some bizarre turns. On pages 21 and 22 of the opinion, they argue that prior measures regulating harmful emissions such as mercury are not precedent because, in that case, a technological fix—wet scrubbers—could bring emitters into compliance while there is no such technology available to lower carbon dioxide emissions from coal plants. In other words, the Court blesses the continued unconstrained emissions of greenhouse gases from coal-fired electrical generation, the biggest single-source contributor to climate change on the planet, because such emissions are an inevitable byproduct of coal-fired electrical generation and shifting power generation away from coal was not explicitly specified by Congress. It’s telling that the majority opinion never disputes that significant, cost-effective emissions reductions from coal cannot be achieved without shifting away from the fuel. The logic of this section makes sense only in a context in which the Court is unconcerned with the threat of such emissions.

As for Kagan’s dissent on the majority’s legal argument on the lack of precedent, she writes that the Clean Air Act was intended to cover novel sources of environmental harm that might develop in the future, and the EPA was delegated the authority to deal with those issues. According to Kagan, the relevant provision of the Clean Air Act “enables EPA to base emissions limits for existing stationary sources on the ‘best system.’ That system may be technological in nature; it may be whatever else the majority has in mind; or, most important here, it may be generation shifting. The statute does not care.”

More evidence of bad faith comes from a reading of the central piece of evidence the opinion cites in supporting the notion that the plaintiffs had standing to bring the case because they could, at some point, be injured parties. The evidence is a 2015 study produced by the Department of Energy estimating that reducing the amount of electricity generated by coal from 38 percent to 27 percent by 2030 would cost jobs, consistently raise energy prices by 10 percent per year, and lower the gross domestic product (GDP) by $1 trillion. A look at what has happened since this study suggests that the majority grabbed any study they could find that supported their argument for harm, regardless of whether it was contradicted by subsequent reality. Had the clerks who dug up this outdated study done a little more research, they would have discovered that here we are in 2022, eight years later and eight years before 2030, and the amount of electricity produced by coal stands at 21.8 percent, more than 5 percentage points lower than the target discussed in the 2015 study. One would think that conservative justices, so enamored of cost-benefit analysis, could do better.

Moreover, try to find the trillion dollars in damage to the GDP resulting from this shift. In fact, the shift away from coal has been an economic plus. In recent years, the biggest creator of jobs in the energy sector has been renewables, not fossil fuels. The Bureau of Labor Statistics put the number of coal jobs in the U.S. at about 37,000 in 2021. Solar and wind power alone amounted to 353,000 jobs in 2018, or nine times that amount. That number is also 74,000 more than solar and wind jobs in 2014, more than compensating for the 40,000 coal mining jobs lost during that same period. It is worth mentioning, again, that the Clean Power Plan was not in effect and, therefore, these jobs were not lost as a result of that policy. As Kagan notes in her dissent, the Clean Power Plan predicted what power generators were already doing, rather than causing them to do anything differently. She writes that “[m]arket forces alone caused the power industry to meet the Plan’s nationwide emission target—through exactly the kinds of generation shifting the Plan contemplated.”

Though the majority opinion tries (and fails) to spotlight the costs of the Clean Power Plan, it never bothers to address the costs of climate change, even though credible estimates are not hard to find. In 2019, Moody’s Analytics estimated that the global costs of a 2 degree Celsius warming would be $69 trillion. Another study by Oxfam and Swiss Re estimated that a 2.6 degree Celsius warming would inflict three times the economic damage of the coronavirus every year going forward. 

That the reduction of the use of coal was achieved without the Clean Power Plan and without trillion-dollar damage to the GDP may point to the real target of this opinion—the authority of regulatory agencies. As Kagan points out, the majority argues that, per the Clean Air Act, Congress needs to explicitly delegate to the EPA the authority to determine how new sources of pollution should be regulated, though when the Clean Air Act was passed in 1970, climate change was not yet an issue of concern. As noted, Kagan cites the language of the authorizing legislation and numerous court precedents to argue that this is precisely what they did. With their focus on explicit delegation, the majority brings into play the possibility of curtailing in the future the regulatory authority of other agencies such as the Occupational Safety and Health Administration, the Consumer Finance Protection Bureau, and the Consumer Product Safety Commission, to cite a few.

The best evidence that the majority’s target was general regulatory authority is that the Court didn’t need to do anything at all. The Clean Power Plan was not in effect, and there was no plan to put it into effect. As Kagan puts it, “[T]he Court’s docket is discretionary, and because no one is now subject to the Clean Power Plan’s terms, there was no reason to reach out and decide this case,” and she goes on to write that the Court could not wait “to constrain EPA’s efforts to address climate change.” 

If the Court’s real target was administrative authority, then action on climate change may turn out to be collateral damage in the majority’s pursuit of the libertarian dream of reigning in the regulatory state. Evidence that the domestic damage may be minor comes from the fact that U.S. electric power production has moved away from coal vastly more rapidly than the original Clean Power Plan envisioned. Kagan points out that many companies in the power sector that would be affected by the Clean Power Plan actually joined a brief in support of the EPA’s position, leaving one to wonder just who would be the injured parties meriting the preemptive protection provided by the highest court in the land. Renewables are now cheap enough, and climate change concerns are increasing rapidly, so market forces and investor and consumer pressures, not government action, are driving decarbonization. Expect that trend to accelerate. And now, new technologies, such as deep geothermal, offer the near-term promise of retrofitting existing coal-fired power plants and producing electricity at half the cost of the cheapest fossil fuel (according to Carlos Araque, CEO of Quaise Energy, which is commercializing a deep geothermal drilling technology developed at MIT). Still, at some level, all governments around the world will have to get involved in order to avoid the current path—one that exceeds a two-degree Celsius warming even if all nations abide by the Paris climate agreement, a temperature level not seen since before humans emerged as a species.

Action on climate change requires collective international action; the U.S. does not operate in a vacuum. As evidenced by China’s emergence as the largest greenhouse gas emitter in the world (going from half of U.S. emissions in 1990 to twice U.S. emissions now), averting the worst impacts of climate change requires buy-in by all large economies. With the Supreme Court kneecapping the EPA’s ability to mandate fuel shifts at home, it makes it that much more difficult for the U.S. to argue such shifts are needed in the economies where coal produces a far higher proportion of electric power.

The most immediate damage resulting from the EPA decision may be to the Court’s reputation. The decision shows the lengths the current majority will go to in order to find straw men suitable to advance its small-government agenda as well as either indifference or obliviousness—take your pick—regarding the most consequential issue of our times. Clearly, this narrow-minded, backward-looking majority is not up to addressing the issues that will determine the quality of life of our children and grandchildren as well as the stability of the planet’s life-support systems. Alas, Sen. Hruska’s dream has come true

contact Eugene Linden

Short Take

HOW THE OPTIONS TAIL HAS COME TO WAG THE MARKET DOG: A Simple English Language Explanation of How Structural Changes in the Stock Markets Contribute to Whipsaw Movements in Prices.

Lately a string of violent price movements and reversals in the equity markets make it look like the markets are having a nervous breakdown. The last day of trading in April 2022 saw a 939 point drop in the Dow. The day before that, the Dow rose about 625 points, and two days before that it fell over 800 points. The very next week, after two quiet days, the Dow rose over 900 points after the Fed announced its biggest rate hike in 22 years (ordinarily a big negative for the markets), and then, the next day, fell over 1000 points (more on this later).  There have been plenty of headlines – about the Ukraine Invasion, inflation, the threat of a Fed caused recession, supply chain disruptions – to justify increased uncertainty, but the amplitude of the moves (and the sudden reversals) suggest something more may be at work. Here follows an effort to explain in simple language the significant changes in the market that have contributed to this volatility.

 

“This time it’s different” is perhaps the most dangerous phrase in finance as usually it’s uttered by market cheerleaders just before a bubble bursts. That said, markets do change, and those changes have their impacts. One change in the markets has been the shift from intermediaries (such as brokers) to direct electronic trading, a shift that has made the markets somewhat frictionless, and allowed computer driven funds to do high speed trading. This shift began a couple of decades ago. Today’s markets can move faster than a human can react.

 

Another shift has been the degree to which passive investing through index funds and algorithmic trading through various quant funds have come to eclipse retail investing and dominate trading. A consequence of this is that to some degree it has mooted individual stock picking because when investors move in or out of index funds, the managers have to buy or sell the stocks held on a pro rata basis and not on individual merit. This change too has been developing over recent decades.

 

A more recent and consequential shift, however, has been the explosion in the sale of derivatives, particularly options (the right to buy or sell a stock or index at a specified price on or before a specific date). Between 2019 and the end of 2021, the volume of call options (the right to buy a stock at a specified price on or before a particular date) has roughly doubled. During times of volatility, more and more retail and institutional investors now buy calls or puts rather than the stocks. 

 

Today, trading in options has reached a scale that it affects market moves. A critical factor is the role of the dealers who write options and account for a significant percentage of the options issued. Dealers have been happy to accommodate the growth in option trading by selling calls or puts. This however, makes them essentially short what they have just sold. Normally, this doesn't matter as most options expire out of the money and worthless, leaving the happy dealer to book the premium. Being short options, however, does begin to matter more and more as an option both moves closer to being in the money and closer to expiration. 

 

This situation is more likely to occur when markets make large and fast moves, situations such as we have today given the pile of major uncertainties. Such moves force dealers to hedge their exposure. 

 

Here’s how it works. If, for instance, a dealer has sold puts on an index or a stock, as a put comes closer to being in the money (and closer to expiration), the dealer will hedge his short (writing the put) by selling the underlying stock. This has the combined effect of protecting the dealer -- he's hedged his potential losses – while accelerating the downward pressure on the price. In other words, this hedging is pro-cyclical, meaning that the hedging will accelerate a price move in a particular direction.

 

Traders look at crucial second derivatives of stock prices, referred to by the Greek letters delta and gamma to determine exposure to such squeezes. As an option moves closer to in the money it's delta -- it's price movement relative to the price movement of the underlying, and its gamma -- the rate of change of the delta relative to a one point move in the underlying, both rise. The closer to both the strike price and expiration date, the more the dealer is forced to hedge. The result is what’s called a gamma squeeze. Once the overhang of gamma exposure has been cleared, however, the selling or buying pressure abates, and gamma may flip, with new positioning and hedging done in the opposite direction. The result can be a whipsaw in the larger markets. This same phenomenon can happen with indexes and futures.

 

How do we know that the hedging of option positioning are contributing to violent price changes and reversals in the market? While not conclusive, perhaps the strongest evidence is that large lopsided agglomerations of options at or near the money have been coincident with surprising market moves as expiration dates approach. In fact, some market players use this data to reposition investments, in effect shifting investment strategy from individual companies to the technical structure of the markets. This is what Warren Buffett was referring to when, at his recent annual meeting, he decried the explosion of options and other Wall Street fads as reducing companies to “poker chips” in a casino.

 

The week of the May Fed meeting gave us a real-time example of how a market move that looks insane on the surface reflects the underlying positioning in various derivatives. To set the stage: ordinarily, given debt burdens and the threat of recession, the markets would be expected to react badly to a Fed tightening cycle that is accelerated by the biggest rate hike in 22 years. On Wednesday, however, market indices began to soar on Wednesday when Fed Chairman Powell, one half hour after the Fed announced it 50 basis point raise, suggested that the Fed was not considering larger 75 basis point hikes during this tightening cycle. Traders interpreted this as taking the most hawkish scenario off the table. Up to that point, institutions were extremely bearish in their positioning, heavily weighted to puts on indexes and stocks, and also positioned for future rises in volatility in the markets. Right after Powell made his comments, investors started hedging and unwinding this positioning, and all the pro-cyclical elements entailed in this repositioning kicked in. By the end of the day, the technical pressures producing the squeeze had largely abated, setting the stage for a renewed, procyclical push downward the next day, as the negative aspects of the tightening cycle (and other economic headwinds) came to the fore. 

 

What these violent moves in the market are telling us is that while in the broader sense, this time is not different --the overall sine wave of the market is still that bubbles build and burst -- how the present bubble is bursting may be following a different dynamic than previous episodes. The changes since the great financial crisis-- the rise to dominance of passive trading through indexes and algorithmic trading through various quant strategies – reduced the friction in the markets as well as the value of picking individual companies. Now, the more recent explosion of option issuance, further accelerates market moves, and leads to unpredictable reversals that have to do with option positioning rather than fundamentals such as earnings, politics, or the state of the economy. 

 

The tail (the options and other derivatives markets) now wags the dog (the equities markets).

 

 



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