ESG: Can Hedge Funds Save Our Oceans?

By Philippe Burke, Portfolio Manager, Apache Capital

phillippe-burkeThere are several ways that large asset managers could demand a change in behaviour from publically traded polluters.

We’ve all read alarming reports of collapsing fish populations, giant rotating ocean gyres filled with consumer plastic, ocean acidification, blanching coral reefs, and melting glaciers.  Our disappearing marine life is a classic illustration of the Tragedy of Commons, and our inability to self-correct is sometimes explained as the natural outcome of an intractable Prisoner’s Dilemma. An illustration follows.

Dilemma

Suppose two rational neighbours live by a pond where a thriving population of 100 fish frolic, growing at a net rate of 10% per month.  The two neighbors meet and agree to protect & maintain the pond’s stock of 100 fish, and share in the growth bounty equally, with each harvesting only 5 fish from the pond per month.  The problem with the agreement is that it would in fact be rational for each neighbor to cheat.  To see that, consider the possible actions of each neighbor: 1) if neighbor A decides to cheat (catches 6 fish instead of 5) and believes that B will not cheat (will catch only 5 fish), A gets 100% of the benefit of cheating, and the communal loss (i.e. diminished fish stock, that could be countered by harvesting a bit less next month) is born equally by A and B; similarly 2) if A thinks B will in fact cheat (catch 6 fish), then it is again in A’s interest to cheat (catch 6 fish), because not cheating would mean that A would bear ½ the cost of B cheating, with none of the upfront benefits in extra fish.

That cost/benefit assessment is of course the same from B’s perspective.  So rather than both neighbours not cheating, which would in fact be in both A’s and B’s best long term interest (e.g. being able to harvest 5 fish per month for ever), it is short-term rational for both neighbors to cheat, and that of course is how we end up with fish populations in free-fall in oceans across the globe.

But the environmental problem is a bit more complex than this simple example suggests: in addition to rapidly falling fish populations, what fish stock remains is becoming increasingly toxic, from rising ocean pollution.  Most ocean pollution comes from the land (e.g. fertilizers, pesticides, mine tailings, plastics); The table below summarizes statistics for the Pacific coastal regions, for illustration.  In short, the Pacific accounts for roughly 50% of global ocean waters, and 99% of commercial fishing is done within 200 miles of coast lines, and within 500 meters of the surface.

In Table 1, we calculate the area of the “donut” of Pacific Ocean coastal waters where most of the fishing is done.  This area also corresponds to where most of the ocean trash is dumped annually.  This enables us to also compute the concentration of trash in coastal ocean waters.  Assuming that toxins account for 2% of trash, and that fish have a concentration of trash-emitted toxins 50 times higher than ambient waters, we find that on average, large fish accumulate toxic concentration levels in their flesh in the range of the EPA’s maximum recommended threshold within two years of life in Pacific coastal waters.

table-1-ocean-pollution

How can this problem be addressed?  Consider the parties that must reach a lasting agreement for this pollution and depletion problem to be reversed:  it is no longer an agreement among fishermen to harvest responsibly, but also among nations to hold pollution in check. Our lake is now the Pacific Ocean, and our two neighbors are now China and the US.  If one neighbor nation grows more rapidly, that nation will likely also increase its share of ocean pollution, impairing the resources and health of both neighbors, and both parties will have an incentive to harvest fish more quickly before the rapidly diminishing fish stock becomes even more toxic. So any agreement between neighbors must include both harvesting and pollution limitations, but as was the case in our simple lake example above, it may be short-term rational for both/either neighbor to cheat on any agreed quotas.

A closer look

To address this problem, let’s begin by modeling the dynamics between the human and fish populations.  At its simplest, we have rising human population leading to an increase in GDP, an associated rise in industrial pollution, as well as greater harvesting of fish for food.  Rising pollution and diminishing fish stock in turn causes higher concentration of pollution in fish populations, resulting in greater food-toxicity and deaths for humans. In sum, humans take fish out of the ocean while adding pollution.  What outcome can we expect for human and fish populations over time?  We have a number of modeling alternatives, including the Schaefer harvesting model and the Lotka-Voltera predator-prey model.  In what follows, we will employ a modified set of Lotka-Voltera logistic equations and examine these dynamics over time.

table-2

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