Wednesday, December 23, 2009

Global Warming Science and DCF Models

The science behind the global warming hypothesis has always struck me as being a lot like the process of evaluating an M&A transaction. Both involve complex modeling in an attempt to predict future events, with the results used to support or refute an investment thesis.

One thing dealmakers know (or should know) is that the utility of a DCF model is constrained by the reliability of its inputs. For this reason, models should be given much more credence when evaluating stable, mature businesses than when modeling dynamic or new operations. For the latter, the "garbage-in, garbage-out" problem renders models little more than an exercise in involved guessing.

So - what to make of global warming science, where the task of modeling planet-wide systems is exponentially more complicated than that involved in even the most speculative of new businesses? Frankly, there's no way to call the conclusions drawn from this exercise, as many have, "settled science."

[As an aside, the concept of "settled science" in any field rings badly in the ear; the work of a scientist should always be to test, re-test and probe at various hypotheses and theories. The history of science is replete with examples of theories that "everyone" knew to be true being disproved.]

Complicating matters further is the curious and near-religious fervor of many GW scientists, complete with crushing of apostates and indications of thumbing the scale in favor of the desired outcome in the models. Modeling is not a precise science, and pretending it is so greatly impacts the credibility of those driving the science.

This doesn't mean the GW scientists are wrong. They could well be right, but does the state of the science - the value of the model - support the investment thesis? Many climate scientists and environmentalists would have us invest trillions of dollars in carbon reduction. Making that kind of investment (an investment which forecloses the opportunity to invest those dollars in other worthwhile endeavors, from disease elimination to feeding the starving to economic growth) absolutely requires rock-solid scientific support.

For now, the state of GW science probably supports tuck-in investment in incremental carbon reduction measures: greater efficiency, more trees, etc. It certainly doesn't support rushing headlong into policies that vastly transform our economy and way of life. Bottom line: If GW science were an M&A transaction, it would look, right now, like the worst case ever of deal fever.

Monday, December 07, 2009

The "Zero-Risk Era"

I could never work be general counsel of a bank - or at least, that's what I've got to conclude after reading this piece in Corporate Counsel about the global risk regulatory paradigm set up in the Basel II Accord. Under Basel II, financial institutions must do sweeping and detailed analysis of "operational risks," complete with meetings, analysis, documentation and record-keeping.

Put aside the process issues and garbage-in, garbage-out nature of this kind of program. Simply think about this: Operating a successful business is a continuous exercise in taking on "operational risk." Hopefully this risk is smart; hopefully it is vastly outweighed by opportunity on the other side. But it involves risks none the same -and working toward a "zero-risk era" is not only fraught with risks of its own, but also does a disservice to that which makes businesses great.