Climate change, and the fight to stop it, will create winners and losers. “Climate risk” is a concept the financial world uses as they seek to understand who those winners and losers will be.
How will the falling price of solar panels affect oil company stocks, and how fast will any changes happen? How likely is an infrastructure project to be damaged by flooding? Which soft drink companies or food producers will fare better or worse in a water-scarce world?
Why care? Because your retirement savings could depend on it
This is important stuff for everyone to understand, especially if you own investments, insurance or have a pension.
To see how seriously major banks and investors are taking climate risk, consider the following. Blackrock, the world’s largest investor, has put its investees on notice, urging them to disclose financial risks related to climate change. Last summer, the firm used its shareholder voting rights to force fossil fuel giant Exxon to explain how it would be impacted by global action to limit climate change to 2℃. The European Union, meanwhile, is moving to make disclosures mandatory by 2020, while institutional investors in France are already required to disclose climate risks by law.
By pushing for climate risk disclosure, major investors are asking companies to be transparent about the risks they face both from the physical impacts of a shifting global climate and the transition to a low-carbon economy. The financial world runs on information, and greater disclosure will help investors make more informed investment decisions.
Talk of a carbon bubble is a warning of what may happen if risks are not well disclosed. The Economist recently reported that markets are likely underpricing climate risk to a dangerous degree. Companies, particularly those involved in the fossil fuel industry, may be overvalued because their exposure to climate change isn’t reflected in their share price.
The good news is that investors are not only gathering information on climate risk – they’re acting on it. That could make a big difference for the climate. An increasing number of institutional investors are investing in green bonds backed by environmentally-friendly projects predicted to fare well in a low carbon future. While the vast majority of green bonds are still restricted to institutional investors, some companies like CoPower (full disclose: I’m currently a CoPower employee) are now offering green bonds for retail investors too.
What are the different types of climate risk?
There are two broad categories of climate risk: physical risk and energy transition risk.
Physical risk from climate change can include damage to fixed assets – everything from buildings and property to supply chain disruptions, and can result from extreme weather events or changes in water availability.
Investors are now able to track these risks in impressive detail. Deutsche Bank, for example, is using a map of more than one million corporate, manufacturing and retail sites globally to gauge companies’ exposure to climate disruptions like hurricanes, heat waves, rising sea levels, droughts and wildfires.
Energy transition risk is no less critical to a company’s bottom line. Bank of England Governor Mark Carney has warned that meeting our global target of limiting climate change to 2°C “would render the vast majority of oil, gas and coal reserves stranded.”
Energy transition risk, therefore, refers to the risk faced by high-carbon companies and industries if the world successfully transitions to a low-carbon economy through policy, legal and technological change in support of the 2°C target set out in the Paris climate agreement.
As the “carbon bubble” concept suggests, an abrupt transition risks destabilizing the financial system.
And these aren’t the only kinds of risks we face from a changing climate. Carbon pricing is an example of policy and regulatory risk. As it becomes more expensive to burn fossil fuels due to a carbon tax or cap-and-trade plan, reserves or pipeline infrastructure once valued highly on an oil company’s balance sheet could become liabilities. Or, as countries implement clean fuel standards, companies producing the most efficient vehicles will have an advantage.
Amongst fossil fuel assets, the dirtiest to burn and most expensive to generate are more vulnerable to energy transition risks. Just look at the decline of the coal industry over the past five years. Similarly, industries that are significant consumers of fossil fuels, like steel or cement manufacturing, are vulnerable to these risks as well.
As the “carbon bubble” concept suggests, an abrupt transition risks destabilizing the financial system. This underlines the importance of early, effective policy action – and policies that allow businesses to plan for a smooth shift away from fossil fuels would be preferable to help avoid sudden shocks.
As real as climate change is the risk of litigation over who wins and loses as we determine a post-climate change world. Since 2011, Columbia Law School in New York has been tracking the number of climate change-related legal cases that have been brought forward globally: 1,185 as of this month.
Most of these cases seek to hold governments or fossil fuel companies accountable for the damage caused by their policies or products, and for inadequate action in the face of clear climate science. High profile cases include New York City vs. Shell & Exxon and the victory of 866 citizens over the Dutch Government, which must now increase its cuts to emissions. Their success will most likely hinge on the ability to draw a direct connection between an impact – a storm like Hurricane Sandy, for example – and the actions of company or government.
The landscape of low carbon technologies, meanwhile, is changing fast. Costs are falling rapidly for technologies like solar PV or electric vehicles, meaning companies and individuals are having to choose today between technologies to power their car, for example, without a clear idea of whether the tech can stand the test of time. How quickly they’ll be able to compete with and replace carbon-intensive technologies is a question most investors are asking.
Get your portfolio on the right side of the low carbon transition
The flip side of climate risk is opportunity. In the long term, where investors in carbon-intensive assets may lose, investors in cleaner assets may win.
On an individual scale, the first step to getting your own portfolio ready for the transition is taking a look inside at what your investments support. As CoPower’s own research has shown, your investments may have more of an impact on your carbon footprint than any other individual action.
Then there are those who manage our money. Is it time to have a conversation with your wealth advisor or pension fund manager about climate change? Money talks, and being clear that this is as much about mitigating against financial loss as it is about doing the right thing for the planet is a powerful strategy for change.
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