Author: plausibleoutcomes

I worked at Lockheed, Brown & Root, and SRI International, and co-founded Strategic Business Insights, a spin off of SRI providing insights about emerging threats and opportunities for multinationals and government agencies. I help organizations address the threats and opportunities of complex environments, develop usable assessments of the future, and make strategic decisions. I co-authored with my scenario planning colleague at SRI, Ian Wilson, the book The Scenario Planning Handbook: Developing Strategies in Uncertain Times. I'm currently working for a imagery satellite startup as the Chief Development Officer.

Emerging-Market Takeover of Commodities

Foresight

Emerging-market organizations will define the future of global trade, often controlling large segments. As commodity prices rebound in the next two years, albeit slowly, the actions of sovereign-wealth funds, commodity producers from emerging-market economies, the crony capitalists running those producers, and Chinese state-owned banks will influence much more the global economy and the large role played by commodities. Key signals that this could happen include the emergence of sovereign-wealth funds with their vast financial sums to invest around the world, the growth of crony capitalists in emerging-market countries, the current global monetary disorder, the declining influence of Western foreign aid and London as a financial center, and the recent rebound in commodity prices after the commodity markets collapse.

Recent Signals of Change

Recent disruptive, big, and out of the ordinary changes affecting global money flows and ownership include:

  • Fueled by commodity prices, particularly oil exports, sovereign-wealth funds—financial vehicles owned by governments—doubled in size from 2007 to 2015 to $7.2 trillion. Since 2007, the number of sovereign funds increased by 44 percent to 79, many in Africa and Asia. Nearly 60 percent of sovereign wealth fund assets are related to energy exports.
  • Many sovereign-wealth funds, including most likely several from the Middle-Eastern oil exporters, came to the aid of the Russian Direct Investment Fund when US and European sanctions restricted business between the Russian fund and Western companies. Sovereign funds don’t behave like traditional institutional investors that typically invest only to produce returns. Sovereign funds often answer to top government officials and may invest not only to produce returns but also to push economic-development or diplomatic initiatives.
  • Developing economies account for 43 percent of global GDP but 65 percent of crony wealth. Crony capitalism is where an individual’s wealth stems from a special relationship with the government. Since globalization took off in the 1990s, the wealth of billionaires in high-crony industries, like natural resources, real estate, construction, telecoms, and defense where there’s a lot of interaction with the state or are licensed by it, grew substantially in developing countries. The Economist’s crony-capitalism index indicates billionaire wealth in crony industries in developing countries has fallen—largely because of the fall in commodity prices—from 7 percent in 2014 to 4 percent in 2016. Russia’s crony industries represents approximately 18 percent of Russia’s GDP.
  • Large commodity traders, like Glencore and Trafigura, have been buying parts of the commodities supply chain. Margins in commodities trading have been shrinking as the efficiencies of the supply chain have improved and data become more abundant, and trading firms are seeking opportunities to take advantage of their commodity insights. Except when commodity prices are volatile, like over the last two years, the trading firms are looking to take advantage of global trade flows.
  • As of July 2016, it appears energy and materials commodity prices hit bottom in 2015 and now are steadily recovering. The commodity fuel (energy) index of indexmundi.com is up approximately 45% since the beginning of 2016, although it’s still 23% down from the highs of a year earlier. Noticeably, private equity firms are beginning again to invest in oil opportunities. The metals price index of indexmundi.com is up 10% for the year, but still down 15% from a year ago.
  • Chinese commodities exchanges are shaping the world’s commodity prices. China accounts for three of the top five trading exchanges for future contracts. While essentially closed to foreigners, the Chinese commodities markets are the world’s largest and drive short-term price fluctuations in the world.
  • Large increases in the issuance of catastrophe bonds are transferring the risks from the insurance industry to capital markets. Currently $72 billion of bonds are outstanding representing a loss of 12 percent of the reinsurance business.
  • London’s role in capital markets and financing sector is falling. UK banks are no longer global leaders. The average global rank of HSBC, RBS, Lloyds, and Barclays by Tier-1 Capital fell from 8.8 in 2004 to 15.5 in 2015. After Brexit, London will likely no longer be Europe’s financial center.
  • Emerging-market banks are now the biggest banks in the world, feeding on the borrowing binges in those markets. The world’s four largest banks are in China, and more than a third of the world’s biggest banks have their headquarters in emerging markets. While banking standards and regulations in emerging markets are improving rapidly, the countries are becoming increasingly leveraged: Bank lending in emerging markets has increased from 77 percent of GDP in 2007 to 128 percent in 2015. In India, non-performing or restructured loans now account for 14 percent of the assets of public banks.
  • Africa’s banks are in serious trouble. Africa’s financial firms did very well after the financial crisis in 2007/2008 as the world demanded the continent’s commodities. In Nigeria, 25 percent of local bank loans went to oil land gas wells. Today with the oversupply of commodities worldwide and sharply lower prices, many African-bank loans are non performing. At Nigeria’s second largest bank, First Bank, 18 percent are non-performing.
  • Global monetary disorder! An array of exchange-rate mechanisms executed by governments around the world for various political and economic reasons is creating more volatility, currency mismatches, and persistent imbalances. A number of governments are intervening in foreign-exchange markets to manipulate currencies to gain export advantage. Two outcomes of this chaos are uncertainty for international businesses—and less investment—and political backlash against global trade.
  • Foreign aid just isn’t efficient: Instead of going to poor, well-governed countries, it is more likely to go to middle-income countries that are poorly governed. While more transparent in the 21st century, the “system” of foreign aid is still failing. Official development aid from more well off countries is still a tool of foreign policy. New cures for poor foreign aid practices continue to be promulgated, often contradicting earlier cures. Official aid is worth about $130 billion a year—a very large sum—but it’s hard to imagine much positive direct impact given the problems it must avoid: Crooks siphoning the money or goods, weak bureaucracies administering the monies, imported goods distorting local markets, and aid monies propping up governments of dictators and prolonging civil wars.
  • Economic migration is so widespread that remittances back to developing economies from workers abroad are now worth twice as much as foreign aid. Remittances are worth 10 percent of the Philippines’ GDP and 42 percent of Tajikistan’s. The cost of remitting money however is quite expensive. On average the cost to send the funds is 7.7 percent. Technology is developing to increase the competition and reduce the costs but regulations to prevent money laundering and financing of terrorism are increasing the risks and costs.
  • Cross-border money payments are a target of cyberattacks. In May 2016, the Society for Worldwide Interbank Financial Telecommunications (SWIFT), the global payments system most banks around the world use to move money, described recent some spectacular cyber bank thefts out of Bangladesh, Vietnam, and Ecuador. Each of the thefts involved re-routing transactions through the SWIFT network.
  • Energy-producing nations of the Persian Gulf are setting records in issuing bonds to offset the revenue declines from lower oil and gas prices. The Gulf Cooperation Council states of Saudi Arabia, United Arab Emirates, Bahrain, Kuwait, Oatar, and Oman together have raised $18 billion in 2016.

Plausible Developments in the Next Five Years

The goal of this analysis is to highlight possible outcomes in the next five years that could be very disruptive. The recent signals of change above suggest we could see the following.

  • Sovereign-Wealth Funds. Sovereign funds will grow in importance in global finance. They will be the means for holding commodity-export monies anywhere in world and using them for whatever purpose.
    • As commodity prices recover, the assets of sovereign funds will likely rebound and grow larger than they were in 2014. The funds will become more intertwined in the global financial system.
    • The investment policies of most of these funds will remain largely obscure. Key investment criteria will most likely continue to include the foreign policy of the sovereign governments and crony benefits.
    • Sovereign funds will become an even more important source of capital for large multinational companies, competing with regulated banks and public capital markets to provide that capital. The new key financiers of the world could be the investment-authority executives of commodity export countries. How might they influence the management of those companies? Might California Public Employees’ Retirement System (CalPERS) decide to exit many energy investments to be replaced by Saudi Arabia state-owned investment funds?
    • Sovereign funds of commodity-export countries may become the financiers of last resort for illiberal governments and organizations subject to international sanctions. Dark money.
    • More schemes by government officials and cronies to siphon off monies of the funds, like the recent case of Malaysia’s 1MDB, will become public.
    • Sovereign funds will experience large volatility in their asset values and performance. A new financial disaster could occur if several large funds simultaneously collapse in some way.
    • The US Justice Department and US Treasury Department will emerge as the primary check on sovereign-wealth fund abuses. No other government organization or international agency will develop the capability to identify and effectively pursue illegal actions involving the global financial system.
  • For the next couple of years emerging-market currencies will remain low relative to the dollar until commodity demand and prices rebound more.
    • The US dollar will remain the strongest currency and global benchmark in the foreseeable future.
    • But the Chinese Yuan will establish itself as the primary alternative.
    • After all the dollar-denominated borrowing by crony commodity-export producers leading up 2015, taking advantage of the low interest rates of the US dollar, many producers will struggle in 2016 and 2017 to cover the dollar interest charges with falling local currency.
    • High inflation, stoked by the currency devaluations, will continue in many countries—Russia, Brazil, Venezuela—until commodity sales improve.
  • Commodity markets. Commodity prices in general will rebound slowly, and the crisis is over except for the radical restructurings of many bankrupt and financially stricken producers.
    • An oversupply situation will continue for several years for most natural resource categories.
    • Commodity producers will continue to perform poorly financially for a couple more years.
    • Large producers will continue to close or divest expensive supply assets, but excess supply will remain in place for several more years.
  • Commodity sellers. But as commodity prices increase, we will see the emergence of powerful crony producers in the next five years and a decline in market share of the multinationals.
    • For the next couple of years, non-state international producers will attempt to lower their costs significantly by restructuring internally and by merging or acquiring other producers and restructuring some more.
    • Some producers, particularly those state-owned, will use extend and pretend practices, trying to sweep problems under the rug.
    • In desperate efforts to develop new business, international corporations will pursue relations with large commodity exporting countries wherever they can, for example Russia, Iran, and Somalia. If they are Western companies, they may pursue opportunities that are against the will of their home governments.
    • Commodity producers from emerging market countries will continue turning into large international competitors as they diversify and grow. More Chinese companies will become international competitors.
    • As a result, multinationals from North America and Europe will lose market share to the new players. State-owned commodity producers from China are already significant players in North America, South America, Africa, and northern Europe.
  • Non-performing loans and solvency of emerging market banks.
    • Many emerging-market banks will likely fail in the next two years, particularly in Africa.
    • If a restructuring of the banks in the different emerging-market countries doesn’t occur, then the rebound of their commodity markets will be delayed.
    • China’s state-owned banks involved in Russia, Africa, and Latin America will take advantage of commodity-export countries’ need for capital.

 

Arctic by Russian Rules

Many of my blogs will focus on an emerging global issue—in this case the Arctic and Russia’s actions there—and provide insights on  possible developments we might see in the next five years. The blog format will be Foresight Summary, Recent Signals of Change, and Plausible Developments in the Next Five Years.

Foresight Summary

Development of oil and gas resources and other mineral deposits in the Arctic will start increasing again now that commodity prices have started to recover. Confrontations with NGOs and local communities over environmental and social problems in all Arctic countries will begin to increase. Russia will continue to strengthen its dominant Arctic position and as commodity prices rebound will exploit the new economic and political opportunities in the region afforded by Russia’s large search and rescue and security resources in the region, the warming climate, and new technologies for overcoming the hazards of the region. The United States is not building economic and security capabilities in the region and will struggle to influence future outcomes. For the foreseeable future Russia will define the rules and ways in which human activities evolve throughout the region. For Norway, the Arctic will continue to be strategic; Norway will continue to invest in the region, led by Statoil the state-owned oil company, and remain the West’s most active operator and negotiator with Russia in the region. As NATO reinforces its capabilities in Eastern Europe, Russia will exert its presence in the Arctic. While China is not an Arctic nation (with land bordering the Arctic Ocean or above the Arctic Circle), the Chinese government and Chinese companies will increase their presence in Russia, Canada, and Greenland. Specialized shipments of oil, gas, and minerals extracted from Arctic deposits will start flowing regularly along the Russian Arctic coast to Asia countries.

Recent Signals of Change

The key to recognizing new trends, anticipating possible developments in the future, and identifying the strategic implications is to focus on recent signals of change in the world—big, disruptive, out of the ordinary changes—in whatever part of the world, physical or societal, they occur. Recent changes related to the Arctic that indicate new trends or developments may be emerging include:

  • As of July 2016, it appears energy and materials commodity prices hit bottom in 2015 and now are steadily recovering. The commodity fuel (energy) index of indexmundi.com is up approximately 45% since the beginning of 2016, although it’s still 23% down from the highs of a year earlier. Noticeably, private equity firms are beginning again to invest in oil opportunities. The metals price index of indexmundi.com is up 10% for the year, but still down 15% from a year ago.
  • According to NASA, the Earth is getting greener in the rapidly warming northern regions. The amount of leaf area per ground area is increasing as a result of warmer northern temperatures and longer growing seasons. Some unknown amount of greenhouse gases is being pulled out of the atmosphere. It’s probably unlikely this will reduce the Arctic warming trends in a major way.
  • The non-governmental organizations (NGOs) with activities above the Arctic Circle are rapidly expanding, except in the Russian sector. The Arctic continues to be getting warmer, and environmental change research in the region continues to expand. At the same time, as social problems don’t seem to go away, particularly among the indigenous groups, NGO activity expands and media coverage increases.
  • Automation technologies and more data will be good for jobs, economic development, and better environmental management. Digital data about the Arctic is expanding very quickly because of increased human activities in the area for environmental, navigation, and economic purposes and the deployment of drones and commercial sensing satellites with large data collection capacities. The Arctic is one location where new automation capabilities and vast quantities of more data will lead to economic growth and job increases.
  • A large luxury cruise ship, the Crystal Serenity, will traverse the Northwest Passage for the first time in August 2016. The trip could be a turning point for Arctic tourism in Canada. Iceland, Greenland, and Norway already promote Arctic tourism. Some NGOs and insurance companies are concerned about the safety and environmental risks.
  • However, Arctic sea routes won’t become major shipping lanes for many years, if ever. It is clear the routes won’t reliably ice free during the summer and late fall for many years, if ever. Shipping traffic on the more navigable Northern Sea Route (NSR) along the Russia coastline has fallen significantly since the high point of 70 ships in 2013. The likely biggest use of the routes will be the movement of Arctic resources (like Russian LNG) to growing Asian markets.
  • Russia continues to develop key infrastructure in the far north. Russia just announced construction beginning in 2017 of another 170 km of rail across the Yamal Peninsula to support the development of natural gas reserves and a new port in the area. President Putin highlighted the railway in his 2016 annual press conference. Russia also just launched in June 2016 its largest and most powerful nuclear-powered icebreaker, the Arktika, for the Arctic. Russia now has six reactor-driven ships for the Arctic; the United States has none. Finally, Russia announced the first of its kind floating nuclear power station has started tests in advance of its deployment in October 2017 in the Arctic.
  • Ship transport of Russian Barents Sea oil along the Norwegian Arctic coast in the first part of 2016 reached new highs because of cumulative oil-development and port infrastructure investments over the last decade in the Russian sector above the Arctic Circle. While US Energy Information Administration in its 2016-published energy outlook shows oil production from Alaska decreasing to less than half its current level after 2030.
  • Russia’s US$27 billion Yamal LNG project within the Arctic Circle will begin operation in 2017. This remarkable project will use West-designed and Far East-built ice-class LNG tankers to enable year-round export shipments from northwest Siberia to European and Asian markets. The LNG tankers are intended for navigation both westbound and eastbound along the Northern Sea Route (NSR), the Arctic seaway along Russia’s coast linking the Atlantic and Pacific. The Russian company, Novatek, has a 50.1% interest in Yamal LNG; China National Petroleum Corporation and France’s Total Group both have a 20% holding; and the Chinese state-owned Silk Road Fund has a 9.1% interest.
  • Russia threatened by NATO in the Arctic. In Vladimir Putin’s July 2016 visit to Finland, he strongly advised the country to stay out of NATO. Both Sweden and Finland are increasing their military cooperation with NATO countries and having debates about joining the organization. The Russian Defense Ministry recently announced the deployment in 2017 of its Podsolnukh beyond-the-horizon radar system in the Arctic. In June 2016 a new law in Russia, aimed at strengthening security along the NSR, gave the Federal Security Service (FSB) responsibility for law enforcement along the Russian Arctic shipping passage. Before, law enforcement responsibilities in the area were distributed among the courts and various government agencies.
  • Sanctions by Western countries against Russia are also impacting Russia’s future development plans for the Arctic region. Russia’s economic development and business ambitions for the Arctic region call for more large investments in oil and gas and civil infrastructure that need international financial and technical support. Sanctions by Western countries, including Norway, Russia’s northwestern neighbor and a non-member of the EU have stopped most Arctic plans from moving forward. The remaining large project with Western capital involvement that was initiated several years ago is Yamal LNG, where the French energy company Total holds a 20 percent stake. Finland was a key supplier to Russia’s building nuclear icebreakers, but the ship equipment orders from Russia have stopped.
  • Despite the sanctions, on some multilateral Arctic matters cooperation with Russia has continued. From 2014 to 2016, a polar code for maritime activity was adopted, an agreement on fishing in the Arctic among the Arctic nations was signed; and an Arctic Coast Guard Forum was started.
  • But on other matters and at the bilateral level, cooperation with Russia has broken down. Russia is restricting Russian NGOs and international NGOs operating in Russia. Russia recently blocked the EU obtaining Arctic Council observer status. Russia recently refused permissions for Norwegian scientists to conduct research in Russia’s Arctic areas, while Norway suspended military to military cooperation with Russia.
  • In contrast to Russia’s commitment to the Arctic, the United States and Canada do not have grand ambitions for economic development in the area; instead they are largely trying to constrain the economic opportunities. At a recent summit between President Obama and Prime Minister Trudeau, they issued a statement pledging to develop low-impact shipping corridors, work toward a ban on all commercial fishing in the Arctic until research can determine sustainable levels, and protect 17 percent of land areas and 10 percent of marine areas by 2020. In April 2015, the United States assumed chairmanship of the Arctic Council for a two-year term and outlined the three priorities of its term: improving economic and living conditions for Arctic communities; Arctic Ocean safety, security, and stewardship; and addressing the impacts of climate change. Neither the United States nor Canada is expanding its navigation and infrastructure investments, including building any new icebreakers. The US Coast Guard has a total of two operational (old) icebreakers compared to Russia’s fleet of approximately forty. China—a nation without any territory above the Arctic Circle just commissioned its second icebreaker.
  • Since Russia’s incursions in Crimea and Ukraine, Norway has assumed a more confrontational approach to Russia’s aggressive behavior in the Arctic. The Norwegian government also recently announced plans to modernize the country’s armed forces and increase its military capital spending. Norwegian Prime Minister Erna Solberg was quoted as saying, “we have an increasingly unpredictable neighbor to the east which is strengthening its military capacity and showing willingness to use military force as a political tool.” Norway’s recent award of a new exploration license to Statoil in disputed waters of the Barents Sea around Svalbard also upset Russia, which claims equal access to resources in the “Svalbard Box,” an area around the archipelago. The Svalbard Act of 1925 gives the Kingdom of Norway full and absolute sovereignty over Svalbard, but provides other countries that signed the treaty with economic rights on Svalbard.
  • As the technological and operational leader in the Arctic region, the partially state-owned Norwegian oil company, Statoil, continues to pursue opportunities throughout the region, including in Russia despite the strained political ties between Russia and Norway and the EU. Statoil’s strategic cooperation with Rosneft involves joint exploration in the Russian Barents Sea and Sea of Okhotsk, as well as pursuing interests in a license in the Norwegian Barents Sea. Statoil plans to drill two wells in the Sea of Okhotsk in the far east of Russia in the summer of 2016. “We are pleased to have entered a key stage in our long term cooperation with our partner, Statoil . . .,” said Igor Sechin, chief executive of Rosneft and an ally of Russian president Vladimir Putin in July 2016. On the other hand, Norway and Statoil would like to continue selling natural gas extracted from Norwegian waters to Europe. But replacing the aging gas fields in Norway has been difficult, and Statoil and other energy companies haven’t yet made the next big discovery in Norwegian waters that would justify building the large necessary gas export infrastructure.
  • China’s support to Russian energy and infrastructure projects in the Arctic is critical but fragile. Russia desperately needs capital for expensive development projects in the Arctic abandoned by western firms due to the sanctions, and China has stepped up to help. For example, the Yamal LNG project and Chinese lenders recently signed a $12 billion loan agreement after two years of talks. But many other agreements signed in the last two years haven’t yet led to firm contracts, and the perception is China has been able to take advantage of Russia’s weak negotiating position. Also, China’s goal of building land and sea routes that will enable Europe to connect more easily with China will effectively reduce Russia’s role as a key trading partner of Europe.

Plausible Developments in the Next Five Years

The signals of change above suggest a number of possible developments and outcomes in the next five years that could affect the well-being of people, organizations, countries, and the environment. For any issue, the possible developments and outcomes in the future could vary significantly given the ranges of uncertainty of the major forces involved. The developments and outcomes listed below are those that could severely impact the people, organizations, governments, and countries engaged in the Arctic.

  • United States and Canada policy positions toward the Arctic
    • US and Canadian priorities for the Arctic are unlikely to change. The focus will be on protecting the environment and limiting exploitation of natural resources.
    • Infrastructure investments are unlikely to increase even though economic activity could expand if the climate continues to get warmer.
    • No new icebreaker for Canada or the United States will be built and deployed in the foreseeable future.
  • Indigenous populations
    • Indigenous groups will continue to receive widespread social services, healthcare, and educational aid.
    • Interesting experiments for using new automation technology to deliver that aid will be implemented.
    • Better outcomes for the groups won’t be achieved in the next five years; most indices in fact will likely continue to remain low.
  • Maritime activity
    • Luxury cruises through Arctic waters will be a major success.
    • But Arctic sea routes won’t become major shipping lanes in the next five years. It is clear the routes won’t be reliably ice free during the summer and late fall for many years, if ever.
    • However, transport of commodities extracted above the Arctic Circle, principally in Russian territory, to Asia along the NSR could become regular.
  • Oil and gas and mining ventures
    • Oil and gas prices won’t rise much beyond current levels ($45/barrel to $65/barrel oil) in the next five years.
    • International oil companies will renew efforts in all countries to find and develop new large oil and gas fields in the Arctic. But except in Norway and Russia, no new exploration will begin.
    • New mining ventures in Greenland, Canada, and Russia will become attractive again.
    • Chinese companies will continue to be major players in the new mining ventures and in Russian oil and gas.
  • Russia
    • Russia will continue to push development of its Arctic territory, build the civil and security infrastructure to support expansion of Russia’s economic activity in the region, and exert Russia’s effective security control over the international navigable waters.
    • Russia could respond with physical action to any further NATO encroachment in the area, including Finland or Sweden joining NATO, deployment of non-Norwegian forces in Norway, etc.
    • Russia may demand different terms for the control and administration of Svalbard and its surrounding waters. Russia will not likely accept Norway’s licensing of disputed oil and gas licenses in waters surrounding Svalbard.
    • As long as the sanctions remain in place, Russia could limit non-Russian trade shipments between Asia and European along the NSR.
  • Norway
    • Like Russia, Norway will continue encouraging development of its northern region. The Arctic region with its social and civil infrastructure needs will receive budget priority.
    • Norway will continue to promote oil and gas development in the Norwegian Barents Sea.
    • Norway will likely expand its security capabilities above the Arctic Circle to remain NATO’s northern leader and limit the coast guard assistance required from Russia.
    • Norway recognizes NATO likely won’t confront Russia over Arctic incursions not involving the mainland. Norway will attempt to mend its political fence with Russia, and seek opportunities for civic and business collaboration.
  • China, South Korea, Japan, India and Russia cooperation
    • Because of western sanctions, Russia will continue focusing on developing Asian nations as trading partners and financiers. The Arctic region will provide multiple opportunities for developing long-term economic relationships.
    • LNG transport from Russia’s Arctic region to Asian countries using the Arctic sea route, NSR, along Russia’s coast could open up the route to other shipments of mined commodities from Greenland, Norway, and Russia to Asia.
    • But Russia will only be moderately successful in attracting investment monies and knowhow from China and other countries that do not support the sanctions. For the non-Arctic states of Asia—China, South Korea, India, and Singapore— the Arctic is not strategic and their long-term commitment to the region is iffy.
  • Environmental research and insights
    • Increased Arctic activity by NGOs will lead to confrontations over oil and gas developments in Arctic waters and with Russian authorities over almost every maritime operation they have in Arctic waters.
    • Confrontations will also increase related to other mineral developments and a host of social, environmental, and business issues.
    • Large increases in the environmental data gathered about the Arctic region will occur because of advances in automation technology, easier access to the area because of warmer temperatures, and more economic assets deployed in the Arctic.
    • The cost of acquiring all this new data and analyzing it will dramatically increase. Major budget fights over Arctic priorities—wellbeing of indigenous populations, new civil infrastructure, security, or more environmental information gathering—likely occur.

 

Aha Insight from the US Army: Strategy for Complex Environments

Strategy/policy approaches are often inadequate for figuring out what we should do because they ignore reality. The world is uncertain, but we try to plan based on what we believe is certain. We should be planning based on hypotheses that the world operates like a complex adaptive system, everything is always changing, and most things about the future are uncertain.

A complex adaptive system is a good model for how the real world operates. Like the real world a complex adaptive system is constantly changing, but not changing in a predictable, linear, incremental fashion. When faced with a real-world situation—a situation that is hard to describe because of poor-quality information, many interconnections, and many uncertainties—we can start with a framework for complex adaptive systems and apply a strategy/policy decision process that will enable us to make some sense of a complex, dynamic situation, understand the limits of that sense, and generate good strategies for the situation. And because we’re dealing with a dynamic system, we need a process that will accommodate the change that will be continuous and prepare us to respond to that change as necessary.

New US Army Doctrine for Complex Environments

One very interesting approach put forth for achieving goals in a complex adaptive system is the proposed management doctrine of the US Army for designing and executing military operations in complex operational environments, like insurgency situations in Afghanistan and Iraq. The U.S. Army Capabilities Integration Center, Training and Doctrine Command, United States Army recently described that doctrine in Commander’s Appreciation and Campaign Design, Department of the Army TRADOC Pamphlet 525-5-500.

As outlined in the US Army’s pamphlet, complexity is significant to military commanders because it’s a basic characteristic of operational problems. The military defines an operational problem as a discrepancy between the state of affairs as it is and the state of affairs as it ought to be that compels military action to resolve that discrepancy. The complexity of operational problems ranges from tame, well-structured problems to those that are extremely complex and ill-structured. Unfortunately, most management doctrine today in the military—as well as in civil-government service and private corporations—is for well-structured problems hence the need for a different doctrine and the understanding for when to apply it.

Well-structured problems are controlled through technical reduction and a systematic method-based solution. They are easier to recognize and characterize. Most modern tactical doctrine of military services fits this mold, specifying the tasks, conditions, and standards for every task in warfare from tank gunnery to conducting a defense. The most structured problems often have just one correct solution, and success requires learning to perfect the established technique.

Medium-structured problems are more interactively complex, and while there is no single correct solution, personnel will agree on the structure of the problem, appropriate tasks, and the end state, but may disagree about how the general principles in doctrine are applied on a specific piece of terrain against a specific enemy. In a medium-structured problem, it is possible for a defense to succeed against one enemy commander yet fail against another under precisely the same circumstances. The difference between success and failure in this case is a function of interactive complexity, rather than a structural or technical difference between the two

In planning for a well- or medium-structured military situation, personnel will focus on the linear phenomena rather than the non-linear. They will focus on the practice of war, which is based upon professional consensus and is authoritatively prescribed in doctrine, rather than the art of war, which is based upon intuition and genius. Leader development processes are not designed to produce geniuses because geniuses are idiosyncratic. Instead, leader development processes are based on previous experience and practice and the linear phenomena that can be controlled and on whose structure personnel can agree.

Ill-structured (also called wicked) problems require a completely different orientation. Ill-structured problems are interactively complex, non-linear, and chaotic—and therefore the most challenging. Unlike well- or medium-structured problems, smart people will disagree about how to solve an ill-structured problem, what should be the end state, and whether the desired end state is even achievable.

A number of challenges need to be overcome to address an ill-structured problem.

  • The first challenge is that at the root of the lack of consensus about how to solve an ill-structured problem is the difficulty in agreeing on the structure of the problem. Unlike medium structured problems, it is not clear what action to take, because the nature of the problem itself is not clear. There’s not even a definitive way to formulate an ill-structured problem. For an ill-structured problem, the information needed to understand the problem depends upon how one defines it. And the solution depends upon how one understands the problem, or how one answers the question: “What is causing this problem?” Ill-structured problems rarely have a single cause, and different stakeholders will see the relationships between the causes and their importance differently. Thus, understanding and formulation depend to some degree upon the perspective of the problem-solver rather than some objective truth. Thus an ill-structured problem cannot be known, but must be surrounded.
  • The second challenge in addressing an ill-structured problem is one cannot understand an ill-structured problem without proposing a solution. Understanding the problem and conceiving a solution are identical and simultaneous cognitive processes. For example, if one describes bankrupt commodity producers as the result of falling demand and lower commodity prices from a weak economy, our solution will be different than if we describe bankrupt commodity producers as the result of building too much supply capacity. The formulation of the problem points in the direction of a particular solution.
  • A third challenge is every ill-structured problem is essentially unique and novel. Historical analogies can provide useful insights for individual aspects of the larger problem, but the differences among even similar situations are profound and significant. The political goals at stake, the stakeholders involved, the cultural milieu, the histories, and other dynamics will all be novel and unique to a particular situation.
  • A fourth challenge is that ill-structured problems have no fixed set of potential solutions. Since each ill-structured problem is a one-of-a-kind situation, it requires a custom solution rather than a standard solution modified to fit circumstances. For well- and medium-structured problems, best practices offer standard templates for action, standard ways of doing things that have to be adapted to specific circumstances. There is no similar kit of generic solutions for ill-structured problems. The dynamics that make an operational problem unique also demand the design of a custom solution. Additionally, there is no way to prove that all solutions to an ill-structured problem have been identified and considered.
  • The fifth challenge is that solutions to ill-structured problems are better or worse, not right or wrong. There is no objective measure of success and different stakeholders may disagree about the quality of a solution. The suitability of a solution will depend upon how the individual stakeholders have formulated the problem and what constitutes success for them.
  • The sixth challenge is that ill-structured problems are interactively complex. Operational problems are socially complex because people have tremendous freedom of interaction. Since interactively complex problems are non-linear, a relatively minor action can create disproportionately large effects. The same action performed on the same problem at a later time may produce a different result. Interactive complexity makes it difficult to explain and predict cause and effect.
  • The seventh challenge is that every solution to an ill-structured problem is a ‘one-shot operation.’ Every attempted course of action has effects that create a new situation and cannot be undone. The consequences of direct action are effectively irreversible. Whenever actions are irreversible and the duration of their effects is long, every attempted action counts.
  • The eighth challenge is there is no immediate and no ultimate test of a solution to an ill-structured problem. The perceived quality of a solution to an ill-structured problem can change over time; yesterday’s solution might appear good today, but disastrous tomorrow as the unintended effects become clearer. Measurable results to a particular action may not appear for some time. This time lag complicates assessment enormously, because in the meantime the operational command may have executed other actions, which will make assessing cause and effect even more difficult.
  • The ninth challenge is that ill-structured problems have no ‘stopping rule’. It is impossible to say conclusively that such a problem has been solved in the sense that a student knows when she or he has solved a math problem. Work on an ill-structured problem will continue until strategic leaders judge the situation is “good enough,” or until stakeholder motivations, will, or resources have been diverted or exhausted.
  • The tenth challenge is that every ill-structured problem is a symptom of another problem. The causal explanation for a problem will determine the range of possible solutions. Yet, solving one problem often reveals another higher-level problem of which the original one was a symptom. The level at which an operational problem is solved depends upon the authority, confidence, and resources of a particular commander. One should not simply cure symptoms, but should rather strive to solve the problem at the highest possible level. However, if the problem is formulated at too high a level, the broader and more general it becomes and therefore the less likely it is to solve particular aspects of the specific problem.
  • The eleventh challenge is that the problem-solver has no right to be wrong. The writ of an operational commander and his staff is to improve the state of affairs as his superiors perceive it. Like others in senior positions of an organization, he is responsible for the consequences of the actions he generates.

Given these challenges facing military leaders, the process for confronting an ill-structured problem—for trying to have a healthy future in a complex adaptive system—has to be very different from how situations were generally approached in the past. The US Army pamphlet identifies several key features for a new approach:

  • Shared development of plausible scenarios. The task of defining the problem will require much more work and insight than before, and it’s not something that can be done top down by the commander. Instead, given the uncertainties and complexities of future situations, commanders must approach the problem with a holistic systems perspective using both bottom up and top down inputs. Ultimately, developing a shared understanding of the external environment situation is a critical success factor in defining the problem and quantitative models won’t be very useful. Instead, qualitative, heuristic approaches will be needed to create a shared understanding of the circumstances and possibilities. Based on my experience, a very good holistic approach for creating a shared understanding of the problem or challenge, and one that recognizes the problem or challenge is going to evolve over time with the actions of the participants and unfolding dynamics, is the scenario development process.
  • Shared strategy decision-making. Since each strategy and action solution will be a function of the shared understanding developed for the particular problem or challenge, a top-down developed solution probably wouldn’t work. The process for developing a solution should involve all the key stakeholders and utilize the scenarios.
  • Prepare for continuous change. Since a critical feature of insurgency conflicts is how rapidly the situation or problem changes over time, all participants are in an unrelenting struggle to learn and adapt rapidly, and they do. Over time the original shared understanding of a problem or challenge will no longer be valid and will need to be changed, resulting consequently in the need for an adjusted strategy and action plan. Organizations will need:
    • A continuous process of strategy, with abilities for ongoing monitoring, assessing, and making adjustments to the action plan;
    • Companies and squads closest to the action in the field need the responsibility and authority to conduct that process and make the adjustment decisions. The best information and awareness of the changing situation is in the field and there’s often not enough time for those in the field to brief those at the top and involve them in a process to develop a suitable response;
    • Individual squad members to be utility players more than specialists, able to play multiple roles as needed. New task responsibilities of the squads are assigned to those best suited to carrying them out. The activities of individuals will shift as required by the circumstances.

Implication for Policy and Strategy Development for Global Situations

If this Army doctrine makes sense for complex operational environments, then private corporations, local government agencies, and community planning committees should all use similar principles when developing strategy. But instead they employ processes that are linear and top down and don’t have a good chance of succeeding. They focus on the certainties rather than the uncertainties; they look at issues in isolation rather than being part of an interconnected environment; they forecast or assume one future rather than anticipate a range of plausible futures; they assume a best solution can be found; and they don’t plan for the inevitable change in the future after implementation begins.

Predicting Future Commodity Developments

The world is always being surprised by the size of commodity-market changes. For something as basic and well understood as commodities, you would think it would be straightforward to predict future outcomes. But experts, strategy makers, and leaders generally fail in this regard—often big time—because social interactions, business dynamics, geopolitical forces, and the bio and physical forces of the earth unfold in complex ways, shaping commodities supply, demand, and price in unforeseen ways, and making prediction impossible. Still, policy and strategy makers have made some progress in the last fifty years. For a start, we know much more about how complex systems operate, and we have learned techniques for characterizing complex environments and projecting possible outcomes so policy and strategy makers in the face of all the uncertainty can make better decisions.

The language of complex social-physical systems provides us a tool for understanding many global trends and creating strategies for how we might respond. What is a social-physical system? It is a complex dynamic of social, political, economic, physical-environmental forces interacting with each other as one interlinked system. Every player in the system is a stakeholder, playing a role and acting in that system. Change in one type of force, social or economic or physical, inevitably affects the others, and it’s not possible to understand the dynamics of one arena in isolation from the others. Social-physical systems can be defined at many levels or scales: the highest level is the Earth system, but any real world issue, like the copper commodity market, the urbanization of Southern California, the development of renewable-energy sources in Europe, or the development of Russian oil and gas reserves above the Arctic Circle, can be defined as a social-physical system. At whatever the level or scale, the result of the cross-acting social-physical forces is a complex adaptive system that behaves in nonlinear ways and is largely unpredictable.

Resilience Thinking and Complex Systems

Much of my understanding of the basic dynamics of a complex adaptive system comes from a small but brilliant book called Resilience Thinking: Sustaining Ecosystems and People in a Changing World by Brian Walker and David Salt. This book provides a great framework for understanding a social-physical system and very useful metaphors for visualizing such a system.

According to Walker and Salt, the complexity of the many linkages, actions, and effects that make up a social-physical environment system is such we can never predict with certainty what the exact response will be to any act or input in the system. The system is relatively stable, but the unfolding behavior of the system cannot be predicted by understanding the individual mechanics of the component parts or any pair of interactions.

Another feature of a social-physical system is that it has the potential to exist in more than one kind of stable state in which the dynamics of the specific forces, structure, interactions and responses would be different. A system will transition from one state to another when changes in several interlinked forces result in a crossing of a threshold and the complete reconfiguration of the system to a different state or dynamic. Shocks and disturbances to a system, such as from a natural disaster, market disruption, etc., can push the system across a threshold into a different state or dynamic, often with unwelcome surprises.

Resilience is the capacity of the system to absorb disturbance, to undergo change, without crossing a threshold to a different system state with its different identity and dynamic. This capacity to undergo some change without a radical change in general dynamic is defined as the resilience of the system. The more resilient the system, the more anti-fragile (a term from Nassim Nicholas Taleb, the author of The Black Swan and Antifragile: Things That Gain from Disorder) it is.

In the metaphor of a ball moving in a basin, the ball is the current state of the system. The basin in which the ball is moving is the set of possible states that can be reached by the system with the general dynamic of the interlinked forces. The system is stable as long as the ball stays in the basin. The boundary or lip of the basin is the threshold. Within the basin, the ball tends to roll to the bottom. In system terms it tends toward some equilibrium state. The shape of the basin is always changing as external conditions change and so is the position of the ball. The net effect is the system is never in equilibrium (i.e., with the ball stuck at the bottom). The distance of the ball from the threshold measures the system’s resilience. The resilience of the system is how much change can occur in the basin and in the ball’s (i.e., the system’s) trajectory before the ball (system) leaves the basin. The closer one is to the threshold, the less it takes to be pushed over. If the conditions cause the basin to get smaller or the ball to be moving faster, resilience declines, and the potential of the ball (system) to cross into a different basin becomes easier.

While social-physical systems involve many interlinked forces, their trajectories in a basin are often governed by only a handful of driving forces. To prevent the ball from leaving the basin, it would be important to identify and understand the drivers that could cause the ball to cross the threshold, know where the threshold actually is, and enhance those aspects of the system that would enable it to remain resilient or adaptable. This can include moving the thresholds, moving the current state of the system away from the threshold, or making a threshold difficult to reach. If the system is stuck in an undesirable basin dynamic, it might be impossible or too expensive to manage the threshold or system’s trajectory, and it might be necessary to transform the very nature of the system.

The scale of the system that we’re focused on (usually a global market or geographic region) is connected to and affected by what’s happening at the scales above and below, both in time and space. For example, the annual maintenance activity for an urban highway system is linked to the longer scale for transportation investments in that urban area that are linked to business growth in the region and demographic changes, etc. At each scale, the system is changing, but the linkages across scales play a major role in determining how the system at another linked scale is behaving. Disturbances at lower scales can influence the dynamic of a system at a higher scale. In the end, every system is composed of a hierarchy of linked morphing systems operating at different scales (both in time and space).

So What Insights about Commodities Can We Develop with This Complex-Systems Lens?

Change is normal: Plan for Change. One reason commodities markets are constantly changing is technology innovation. Innovations can help lower production costs, develop new production sources, create new products, and enable increased demand. They can’t be individually predicted, but a wide variety in innovations will shape commodities outcomes throughout the world for the foreseeable future. The scope and scale of impacts on commodities from technology innovation:

  • Agriculture-seed hybrids and herbicides. Technology innovation by large corporations has had a tremendous impact on global food supply and the costs of food. Several large companies like Monsanto, Syngenta, Bayer, Dow Chemical, BASF, and DuPont now dominate the business of food supplies. A key competitive factor for these companies that drives corporate decisions is their ability to innovate in the future.
  • Commercialization of solar energy. The demand for solar-energy solutions is a major factor in national energy policies in both developed economies as well as developing economies. That demand is directly influenced by the production costs of the solar solutions as well as the cost of production for competitive hydrocarbon supplies. Africa is a continent with a lot of sun. It’s also a continent that lacks electricity in many parts. The rapidly falling costs of solar panels may mean that much of Africa’s growth in electricity demand could be supplied by solar.
  • Cyberattacks on financial institutions. Commodity markets are global, and buyers and sellers in different parts of the world depend on a secure global payments systems. The Society for Worldwide Interbank Financial Telecommunications (SWIFT), a network that banks use to move money around the world, recently announced its concern about cyber-heists. Experts believe many attacks have yet to be discovered because the criminals are always getting better.

Future market outcomes can’t be predicted because of the complex interactions of market, political, economic, social, and environmental forces.

  • Global Economy. Most commentators discuss the world economy as if it’s a static system where good logic should enable reasonable projections in the short term (the next year) and the long term (the next decade). Because the global economy is a complex system, it’s just not possible to predict anything. A recent headline in January 2016 in the Wall Street Journal before the World Economic Forum in Davos said, “Welcome to the Crisis Economy, Where Tumult Reigns.” The article argued the “economic and geopolitical outlook appears more unsettled this year than in the past” because of the uncertainties in geopolitics, commodities, energy, and the financial markets. But that unsettled state didn’t stop the article from including projected single-point growth rates for China, the United States, Japan, Russia, and the Eurozone for 2016. The article was correct to highlight the important uncertainties facing the world. But it should not have shown single-point forecasts for the different nations. Instead it should have argued that when tumult reigns the range of potential economic outcomes for the different nations in 2016 could be quite wide and then it should have provided some indication of those ranges. So instead of saying the growth rate for China’s GDP was going to be 6.3% in 2016 compared to 6.8% in 2015, it should have said the growth rate for China’s GDP could be as low as 3% and as high as 8%. This range of 3% to 8% has a very different implication for commodities markets than the single point of 6.3%.

Extreme change may indicate a threshold boundary is about to be or has been breached.

  • A recent article in The Economist on May 28, 2016, “Global Warming: In the red. The end of El Niño sees temperatures soar across the world,” said that the current year would most likely be the warmest on record, and by a wide margin. A major factor in the high heat could be the just-ending El Niño, the Pacific Ocean dynamic of changing atmospheric heat and moisture. The article makes links between the recent high temperatures, the ocean’s heat-storing abilities, and climate change, but says those are tenuous, and that “the complexity of climate systems means temperature variations cannot be explained by a single cause.” For those watching though, the ball might have just left the basin. Supply of agricultural commodities is affected by both the immediate and long-term heat and moisture changes in the atmosphere and clearly will be severely impacted by future higher temperatures. At the same time, warmer temperatures in the upper-latitude and Arctic areas could change the mineral and metal supply opportunities. New sources for many materials may become financially viable in the next 20 years.

First Blog Post: Global Futures Framework

My name is Bill Ralston. This is a blog of hypotheses about the future based on emerging trends and signals of change. After many assignments developing scenarios of the future for businesses and government agencies, I get to present my views on key forces shaping the globe. I will often focus on commodities—ranging from agricultural products, to minerals and metals, to oil and gas, to fresh water—that drive economic development of emerging economies and are a major factor in the politics, economics, changing physical environment, and social priorities of developed economies. Few appreciate how dynamic Mother Earth is and how extreme the shifts in supply capacity, commodities demand, and resultant money flows can be. Economists, government leaders, and business interests continually overlook commodities’ importance and are often surprised by the wrenching turns of the markets. They simply don’t have good mental models for how commodities markets operate in our complex world and can’t appreciate the range of plausible outcomes they could be facing in both the near- and long-term futures.

In my business life I worked at Brown & Root, SRI International, and Strategic Business Insights. I started off as an engineer, helping design and build oil and gas facilities around the world. I then consulted to energy companies and civil infrastructure operators on strategy, technology, and business issues; I moved into consulting on what businesses and government agencies should do about environmental, health, and safety issues; and eventually found a role where I could integrate all my experiences: I became a corporate futurist, helping management teams develop scenarios of the future for the major issues they were facing. Throughout all of this, I was learning about decision-making under uncertainty, risk management, models of complex environments, and making projections about the future.

In this blog, I want to develop a global futures framework that will enable better insights about challenges the world faces. I want to apply this framework to a host of emerging issues and identify future plausible outcomes that businesses, governments, and societies could face. My analysis template will be (i) hypothesis about future threat or opportunity, (ii) recent signals of change, (iii) plausible outcomes in the future, (iv) implications, and (v) what to watch for in the future.

Emerging issues that are on my agenda to address include ocean-development opportunities and risks; Latin America economic-growth prospects; opening up of the Arctic; commodities dependency of emerging economies; civil infrastructure needs; global agricultural supply; petroleum in the future; climate change policies; Africa and China; Russia and the United States: the world’s largest commodity suppliers; the importance of technology innovation in commodity industries; European-nation energy strategies, etc.

Thank you for reading.