Existential Risk
Climate Change / Economics

Andrew Winston in the HBR ... ECONOMY ... The Data Says Climate Change Could Cost Investors Trillions

Burgess COMMENTARY

Peter Burgess

ECONOMY ... The Data Says Climate Change Could Cost Investors Trillions

An important new study, published in the journal Nature Climate Change, says that climate change will be expensive. Extremely expensive. It turns out that if you mess with the planet’s thermostat, it’s not great for the economy or investments. Forget the polar bears; your pension and retirement funds are in trouble.

It’s not the first time economists have warned us about the costs of a changing climate. Some past studies on climate economics, like the famous Stern Report a decade ago, assessed the macro-level risk to GDP as a whole. Others have drilled down to explore what worldwide action to control carbon would mean for fossil fuel investments specifically. But this new report, by estimating the risk to all financial assets and portfolios, finds a powerful middle ground that should get investor attention.

If we stay on the current emissions path, the study predicts, the value at risk in global portfolios could range from about $2 trillion to $25 trillion. In a bit of understatement, Simon Dietz of the London School of Economics, the lead author of the report, told The Guardian, “long-term investors…would be better off in a low-carbon world.”

Estimates of climate risk in the trillions are unfortunately getting more common. Last year, Citi produced a powerful study of the costs and benefits of shifting the energy system toward low-carbon technologies. Unchecked climate change, Citi said, could cost the world $72 trillion by the middle of the century. But the big surprise in Citi’s report was the cost of building the low-carbon economy: the world can spend $2 trillion less in total on energy infrastructure and ongoing fuel costs than it would in the business-as-usual scenario. So we save $2 trillion and avoid losing up to $72 trillion in economic activity.

As compelling as that sounds, the numbers in the Citi study may be too macro to get the attention of investors. When investors look at climate risk – if they do at all – they’ve focused mainly on what worldwide action to reduce carbon will do to the fossil fuel industry. Holding global warming to 2-degrees Celsius will require keeping huge quantities of fossil fuels in the ground. These so-called “stranded assets,” sitting on petro-company balance sheets, are essentially worthless. And thus those companies are massively overvalued.

The stranded assets argument sounds (financially) scary, but it hasn’t been quite enough to truly shift capital flows toward the clean economy. Dietz’s new research, by saying that climate change is a threat to all assets, could get a much broader coalition of investors moving. Some longer-term investors, mainly pension and sovereign funds, are already very concerned and taking action. Norway’s $900 billion fund divested from coal last year, for example. These funds need to think decades ahead, which is well within the time horizon of some very real – and frightening — climate impacts.

Consider another recent scientific study with enormous ramifications for anyone living in, or investing in, coastal property. Some eminent scientists concluded that the sea level rise that they thought would occur over centuries is now likely to happen in just decades. The obvious implication is that any investment tied to physical, coastal assets could be at real risk. These time frames are not theoretical for long-term asset owners. A 20-something teacher contributing to her state pension today will expect a payout 50 years from now… around the time that huge areas of Boston, New York, Miami, and New Orleans could be unlivable.

But it’s not just the investment community that should rethink where its capital goes. Any large company needs to take a hard look as well. A couple of key questions to ponder:

... Do you, or your suppliers, have significant coastal assets? And what is the risk of devaluation? In other words, does it really make sense for a hospitality or real estate company to build a new hotel, apartment, or office complex right on the coast in Miami? Or should any company build a factory with significant water needs in a water-stressed area? Will that asset be operational or retain its value over the normal depreciation period?
... Where are your financial assets invested and in what classes? Do you have significant exposure to coal or fossil fuels in your holdings? What about your employees’ 401Ks or pensions? If you ignored warnings a few years ago about the imminent demise of the coal industry, you may be losing your shirt now.
... On the upside, what opportunities might arise from a popping carbon bubble? There will be winners and losers, so where will those winners be?
... There aren’t easy answers to these questions, but I know very few companies that are even considering them. Thinking about systemic risk playing out over decades is out of the realm of normal business experience, particularly in today’s climate of short-termism. We have no practice dealing with issues like this.

Putting a value on the risk or opportunity is an important first step to make it all understandable to business. And the numbers these banks and academics are coming up with certainly help stir the souls (or wallets) of the investor community. But on some level they’re absurd. When you get into the tens of trillions, you might as well say infinite. The scale of the downside is so large, it’s worth significant effort and investment to avoid it. Let’s hope business leaders and policymakers heed the warning and seize the opportunity to build a more profitable and resilient low-carbon world.

Andrew Winston is the author, most recently, of The Big Pivot. He is also the co-author of the best-seller Green to Gold and the author of Green Recovery. He advises some of the world’s leading companies on how they can navigate and profit from environmental and social challenges. Follow him on Twitter @AndrewWinston. This article is about ECONOMY
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