Climate Change: investor risks and opportunities
Financial Risks
Opportunities
Physical Risks
Water Scarcity and Drought --
Risk Implications for Investors
Timing: Near-Term Mid-Term Long-Term Severity: High Low Impact: Focused Diffuse
Energy, water, agriculture and climate are linked in ways that are already have having impacts agriculture and will increasingly begin to affect investment returns that depend on food supplies and water supplies for agriculture, industry and the production of energy. Nearer term droughts and more severe weather have already taken a toll on agriculural costs and output. With temperature increases come increases in evaporation, changes in precipitation patterns and changes in storm frequencies and intensities. Higher temperatures also increase rates of glacial melt — one of the world’s most important freshwater sources.
Changes in availability of water and decreases in water quality, particularly in the face of continued growth in demand for water will, over time, create significant challenges for businesses and investors who have taken clean, reliable and cheap water for granted. The Intergovernmental Panel on Climate Change (IPCC) states that global warming will lead to “changes in all components of the freshwater system;” concluding that “water and its availability and quality will be the main pressures on, and issues for, societies and the environment under climate change.”
China and India are already being affected by depleted groundwater supplies and decreases in glacial melt runoff for their important rivers. California’s drought is having meaningful effects on agricultural output and prices. Several European countries have curtailed nuclear power due to a combination of heat and low water supplies. Other industries that will be affected include the electric power industry, apparel industry, bio-industrial facilities, pharmaceutical manufacturing, forest products and metals/mining firms; impacting their productivity, costs, revenues, public goodwill and reputation.
Currently, 1.6 billion people live in countries and regions with absolute water scarcity and the number is expected to rise to 2.8 billion people by 2025. As the map below shows, major parts of the globe will be under severe water stress within the next 15-25 years. Image from: http://thinkprogress.org/climate/2012/03/03/437051/syria-climate-change-drought-social-unrest/
Water risk and stress in the United States is similarly growing and will asffect large sections of the ntion's agricultural belt.
Image from: http://www.nrdc.org/globalwarming/watersustainability/
Sources:
http://pacinst.org/wp-content/uploads/sites/21/2014/04/growing-risk-for-business-investors.pdf
"Water and Climate Change: Understanding the Risks and Making Climate-Smart Investment Decisions"
http://www.gracelinks.org/2380/the-impact-of-climate-change-on-water-resources
Rising Temperatures --
Risk Implications for Investors
Timing: Near-Term Mid-Term Long-Term Severity: High Low Impact: Focused Diffuse
Heat extremes that were once in a hundred year events are increasingly occurring annually and are likely to become the norm in summer months rather than the extreme over the next two decades. The effects of extreme heat are expected to be greatest over land and are more likely to have an impact in the Mediterranean, North Africa, Middle East and parts of the United States.
Although 2014 is so far the hottest year on record, 2015 is on track to beat that record and 2016 is looking to continue the trend. Of the 22 studies scientists have submitted to the Bulletin of the American Meteorological Society over the past four years, only one didn’t find that climate change increased the odds or severity of extreme heat. As a result, heat extremes that previously only occurred once every 1,000 days are happening four to five times more often, according to a new study in Nature Climate Change. [Note 1] In that study, the authors find that 18 percent of today’s moderate precipitation extremes, and 75 percent of moderate heat extremes, were made more likely to occur by global warming. They believe that future warming will shift the odds even further: “The probability of a hot extreme at 2C warming is almost double that at 1.5C and more than five times higher than for present-day.”
Chart Source: http://www.climatecentral.org/news/extreme-heat-climate-change-19641
Worker productivity has already declined during the hottest and wettest seasons in parts of Africa and Asia. By 2050, more than half of the afternoon hours of outdoor work are projected to be lost to the need for rest breaks in South East Asia. These changes could significantly reduce economic output in sectors involving heavy labour (e.g. construction), or may require significant investments (e.g. in cooling equipment) to enable economic output to be maintained.
The Team at Risky Business [Note 2] put together a report titled: HEAT IN THE HEARTLAND: CLIMATE CHANGE AND ECONOMIC RISK IN THE MIDWEST. Although it is focused on a relatively small part of just the United states, its findings are illustrative of the types of effects we will likely see:
-
Rising heat is likely to affect the Midwest region’s ten major metropolitan areas through higher heat-related mortality, increased electricity demand and energy costs, and declines in labor productivity. Meanwhile, without significant adaptation on the part of Midwest farmers, the region’s thriving agricultural sector—particularly in the southern states—is likely to suffer yield losses and economic damages as temperatures rise.
-
By the end of this century, the average Missouri resident will likely experience 46 to 115 days above 95° F in a typical year—about as many extremely hot days as the average Arizonan has experienced each year in recent decades.
-
Summer average temperatures in Minnesota, Wisconsin, and Ohio are expected to be hotter by century’s end than average summer temperatures in Washington, D.C., today.
-
The average Chicago resident is expected to experience more days over 95° F each year by century’s end than the average Texan does today, with a 1-in-20 chance that these extremely hot days will be more than double Texas’s average.
-
Rising humidity combined with increased heat across the region will likely mean more frequent days that reach extremes on the “Humid Heat Stroke Index.” There is a 1-in-20 chance that the city of Chicago will experience more than 10 days per year by the middle of this century with heat and humidity conditions similar to the heat wave of 1995, which caused approximately 750 deaths.
A second Risky Business Report, titled: Come Heat and High Water: Climate Risk in Southeastern U.S. and Texas, says that rising temperatures will be responsible for as many as 1,840 additional heat-related deaths in the state of Florida each year and the average number of days with temperatures over 95 degrees is likely to increase from seven now to 32 by 2020-2039. By mid-century, temperatures will exceed 95 degrees 76 days a year, the study projects.
Note 1: http://www.nature.com/articles/nclimate2617.epdf
Note 2: http://riskybusiness.org/uploads/files/RBP-Midwest-Report-WEB-1-22-15.pdf
Rising Sea Levels --
Risk Implications for Investors
Timing: Near-Term Mid-Term Long-Term Severity: High Low Impact: Focused Diffuse
The world’s coastal areas are particularly exposed to the effects of climate change. Higher seas imply greater financial risk for coastal cities, where populations are growing. Low lying coastal zones constitute 2% of the world’s land area but contain 10% of its population. By 2010, roughly 270 million people and $13 trillion worth of assets were exposed to 1-in-100 year extreme sea-level event. In addition, more than $3 trillion in port infrastructure assets in 136 of the world’s largest port cities are vulnerable to extreme weather events. A New Risky Business Report: “The Economic Risks of Climate Change in the United States,” notes Louisiana and Florida will be hit hardest by property damages due to rising sea levels. By 2030, existing coastal property worth $19.8 billion in Louisiana will likely be below mean sea level, and by 2050, the value of that property increases to between $33.1 billion and $44.8 billion. In Florida, losses of existing property will likely range between $5.6 billion and $14.8 billion by 2030 to between $14.8 billion and $23.3 billion by 2050, the report states.
Globally, sea level-rise by 0.5 to 1 meter by 2100 is likely, with higher levels also possible. Some of the most highly vulnerable cities are located in Mozambique, Madagascar, Mexico, Venezuela, India, Bangladesh, Indonesia, the Philippines and Vietnam.
More frequent flooding would likely disrupt insurance underwriting and with it the financing that drives development in cities such as Miami. Higher insurance premiums, in turn, could lead to dire outcomes because there will come a tipping point where insurance is no longer affordable or available. That, in turn, will dramatically affect the availability of mortgage prices and depress housing prices.
The U.S. Department of Defense is particularly concerned because of the number of bases that lie in coastal areas. Sea level rise around these bases will likely lead to:
-
increased storm damage to coastal infrastructure
-
more rapid coastal erosion
-
shoreline change including the possibility for total loss of protective natural barriers
-
saltwater intrusion into aquifers and surface waters
-
rising water tables
Storm Frequency and Severity --
Risk Implications for Investors
Timing: Near-Term Mid-Term Long-Term Severity: High Low Impact: Focused Diffuse
Virtually every study of extreme weather events done over the last 20 years shows increasing potential intensity as the climate continues to warm. On average it appears that we get about 10 additional mph of storm speed for every degree centigrade of tropical sea surface temperature increase, or roughly 20 mph for each doubling of atmospheric CO2 concentration.
In a recent Nature Climate Change paper, Jim Elsner and Namyoung Kang found that rising ocean temperatures are having an effect on how many tropical storms and hurricanes develop each year. They posit that over the past 30 years, storm speeds have increased on average by 1.3 meters per second—or 3 miles per hour—and there were 6.1 fewer storms than there would have been if land and water temperatures had remained constant. As such, they were one of the first to identify the seeming tradeoff between frequency and intensity. [Note 3] http://phys.org/news/2015-05-climate-frequency-intensity-hurricanes.html#jCp
Notwithstanding their research, the intensity, frequency and duration of North Atlantic hurricanes have all increased since the 1980s. So has the number of strong hurricanes, category 4 and 5. The most vulnerable regions are in the tropics, sub-tropics and towards the poles, where multiple impacts are likely to come together.
Between the 1950s and 1990s, the annual economic losses from large extreme weather events, including floods and droughts, increased ten-fold. More specifically, research suggests that in 2005, 2-12% of economic losses from hurricanes was likely to have been caused by climate change, with costs totaling $2-14bn. Even after adjusting for increases in wealth and population over time, the amount of increase in economic loss is consistent with observed warming, changes in the number and intensity of tropical cyclones in the North Atlantic basin and in the number of loss-generating landfall events.”
Food Security --
Risk Implications for Investors
Timing: Near-Term Mid-Term Long-Term Severity: High Low Impact: Focused Diffuse
Both continued population growth and dietary changes that are increasing meat consumption are expected to lead to a 70% increase in food demand over the next few decades. This results in both a greater agricultural impact on climate and a greater cost of agricultural production due to climate change. As food is produced, processed, packaged, transported, prepared, and served, each stage of that process produces greenhouse gases. Increases in beef consumption also mean increases in methane, which is produced by livestock during digestion. In 2012, ten percent of the EU’s greenhouse gas emissions were from agriculture – but that number represents a 24% decrease from 1990 levels, due largely to a decline in livestock numbers, more efficient use of fertilizers, and better manure management.
Agricultural impact on climate change in the rest of the world is increasing. Between 2001 and 2011, global emissions from crop and livestock production grew by 14%. The increase occurred mainly in developing countries, due to a rise in total agricultural output.
On the other hand, changing rainfall patterns and rising temperatures and indirect climate impacts such as increased competition from weeds, expansion of pathogens and movement of insect pest ranges and seasons are already leading to higher prices and increased volatility in agricultural markets. Higher and more volatile prices have already been implicated in geopolitical instability and conflict. Other broader trends of impact include regional warming and drying, extreme temperature and precipitation, carbon dioxide fertilization and ocean acidification, and these have secondary impacts on crop yield, biodiversity, water use, soil fertility, irrigation methods, and fertilizers. In addition, changing climate often increases the presence of weeds, pests, and fungi that thrive under warmer and wetter conditions.
Climate change has negatively affected wheat and corn yields both in global averages and more so for particular geographies. Effects on rice and soybean yield have been smaller in major production regions and globally. Source: IPCC, AR5 WGII, Chapter 7, October 2014
Financial Risks
Real Estate Losses --
Risk Implications for Investors
Timing: Near-Term Mid-Term Long-Term Severity: High Low Impact: Focused Diffuse
Real estate risk includes both risk in the form of property ownership costs, such as insurance costs and casualty losses, but it also includes risk to future value, cash flows and exit opportunities. Terminal value considerations for low lying coastal properties and properties in season vacation areas, such as ski resorts, may change as perceptions about the impact of climate change change.
A new report titled: Come Heat and High Water: Climate Risk in Southeastern U.S. and Texas, the group “Risky Business” funded by former New York Mayor Michael Bloomberg, former U.S. Treasury Sec. Henry Paulson and Thomas Steyer, founder of Farallon Capital Management LLC, looks at unique vulnerabilities and projected climate change impacts on Alabama, Arkansas, Florida, Georgia, Kentucky, Louisiana, Mississippi, North Carolina, South Carolina, Tennessee, Texas and Virginia. According to the report, “Florida faces more risk than any other state that private, insurable property could be inundated by high tide, storm surge and sea level rise." In Florida, up to $69 billion in coastal property not at risk today will likely be at risk of inundation at high tide by 2030. By 2050, the value of at-risk property below local high tide levels will increase to about $152 billion. In addition, the value of coastal property that will be below mean sea level will range from an estimated $5.6 billion to $14.8 billion by 2030 and between $14.8 billion and $23.3 billion by 2050.
The effect of climate change on real investment decisions is today still very muted. However, as situations develop, regional, state or federal policies may be put into place that may meaningfully impact real property valuations. For example, the Federal Emergency Management Agency (FEMA) rezoned parts of Lower Manhattan post Hurricane Sandy, largely as a result of heightened insurance claims. Longer term, such reassessments by either regulators or the insurance industry will impact new construction, development potential, and design requirements for flood protection. Commercial property owners are increasingly being required to reduce greenhouse gas emissions from their properties and to provide for and relocate equipment such as flood-safe electrical connections and back-up generators.
A second Risky Business Report titled: “The Economic Risks of Climate Change in the United States,” concluded that between $66 billion and $106 billion worth of existing coastal property will be below sea level by 2050. In 2013, a similar assessment by FEMA stated that in U.S. areas at risk of flood could increase by 45 percent by 2100, mainly because of climate change. Another report in 2014, this one by the Urban Land Institute titled: “Extreme Weather Events and Property” found the number of extreme storms and droughts had doubled worldwide since the 1980s and was now averaging over 800 events per year. It further found that over the past decade, direct losses related to real estate and infrastructure have tripled, reaching US$150 billion annually. It concluded that “when trends in urbanization and catastrophes are combined with other uncertainties, risks and the general inapplicability of traditional systems to cope and respond, reliable risk analysis and traditional risk management are threatened.”
The author of the book High Tide on Main Street, oceanographer John Englander, warned of the coastal crisis a week before Hurricane Sandy saying that he expected that within a decade, awareness of sea level impacts on coastal real estate will spook the marketplace; causing insurance premiums to spike, mortgages to become harder to obtain, and property values to plunge, along with local tax revenues, making it harder for communities to adapt to new realities.
Solomon Hsiang, of the University of California Berkeley and Marshall Burke of Stanford University, have compiled economic data from 166 countries over 50 years and have come to the view that the outdoor optimal temperature for human productivity is 13 Celsius (55 Fahrenheit). Throughout the 20th Century the global average temperature was 14 Celsius (57 Fahrenheit), last year it reached 14.5 (58.24), and this year it is on a pace to surpass even that. Based on their projections the authors calculate that as the United States warms through the rest of the century, gross domestic product (GDP) per capita will drop 36%. In the authors’ views: “climate change is basically devaluing all the real estate south of the United States and making the whole planet less productive......Climate change is essentially a massive transfer of value from the hot parts of the world to the cooler parts of the world." Their study implies that overall: 77% of countries will be poorer in per capita terms and the impact of warming will have greatest negative affect on Sub-Saharan Africa, South and Southeast Asia, the Middle East-North Africa, Oceania and Latin America.
Insurance Losses --
Risk Implications for Investors
Timing: Near-Term Mid-Term Long-Term Severity: High Low Impact: Focused Diffuse
For much of the insurance industry the rule has been: “Experience is the best tool for predicting of future risk” Unfortunately, climate change is one area where that maxim is likely to lead to trouble. Some have estimated that currently modelled insurance losses could be off by half if recent weather trends become the new normal. According to the Center for Insurance Policy and Research: Insurance firm Munich Re has estimated that weather related losses increased nearly fourfold in the United States since 1980 with extreme weather events (such as prolonged droughts, hurricanes, floods, and severe storms) leading to $510 billion in insured losses from 1980 to 2011.
The National Association of Insurance Commissioners (“NAIC”) first began paying attention to climate change in 2005. In 2008 it released a white paper titled “The Potential Impact of Climate Change on Insurance Regulation.” The white paper recommended development of a framework to collect information relevant to the impact of climate change on insurers. By 2013, the NAIC adopted revisions to its “Financial Condition Examiners Handbook.” These revisions provided examiners with needed guidance on what questions to ask insurers regarding any potential impact of climate change on solvency. Today at least 18 states administer the survey and California requires all companies writing more than $100 million in direct premiums to respond. The survey is designed to assess company strategy and preparedness with respect to climate change in terms of investment, mitigation, emissions/carbon footprint and engaging consumers.
Ceres, a Boston-based nonprofit “sustainability advocacy” organization, has analyzed the insurance company responses and concluded that: “Most of the companies responding to the survey reported a profound lack of preparedness in addressing climate-related risks and opportunities.”
In 2010, the Securities and Exchange Commission (SEC) adopted voluntary disclosure guidelines for all publicly funded businesses related to the potential business impacts of climate change. On a related note, because of a likely increase in shareholder lawsuits, a major insurance broker has stated that “best practices” call for “enhancing” existing D&O insurance to expressly include coverage for potential “environmental mismanagement claims.”
More recently, a coalition of insurance companies, consumer groups, and environmental advocates urged the United States to overhaul its disaster policies in the face of increasingly extreme weather; implying the government needed to increase how much it spends on pre-disaster mitigation efforts and infrastructure protection.
Although the data is fairly clear that disaster losses are growing, factors such as inflation and increasing development in areas subject to natural disasters also play a role. A study by Lloyd’s of London estimated that the 20cm rise in sea-level at the tip of Manhattan since the 1950s, when all other factors are held constant, increased insured losses from Superstorm Sandy by 30% in New York alone.
In 2005 catastrophe losses totaled $64.3 billion. Hurricane Katrina caused losses of $41.1 billion, the highest on record, about twice as much as Hurricane Andrew would have cost had it occurred in 2005. If, as suggested, hurricane-related losses grow by as much 40 percent over the next 20 years, a Katrina-like storm could cause $60 billion in losses, or significantly more if it struck a densely populated metropolitan area like Miami or New York City. Indeed, after Hurricane Katrina in 2005, rating agencies that evaluate the financial health of property insurers raised the threshold for capital adequacy. They now look at capital adequacy relative to a company’s exposure to losses from a 250-year event, rather than 100-year event, and at potential losses from two mega disasters in rapid succession.
In the United Kingdom an extensive study on the readiness of the UK insurance industry came to the following conclusions: “The use of catastrophe risk modelling, portfolio diversification, alternative risk transfer and short-term contracts would suggest general insurers are reasonably well equipped to manage the current level of direct physical risks. Over the past 20 years, the industry has developed more sophisticated approaches to modelling risks from catastrophes and other weather-related events. This has supported more robust pricing of risk, albeit with models generally built to provide estimates of today’s risk, not to anticipate future climate trends.”
The UK report also pointed out, however, that a global transition to a lower carbon economy could have an impact on insurance firms through their investments in carbon-intensive assets. In particular, it singled out (i) securities of firms that might be impacted directly by regulatory limits on their ability to produce or use fossil fuels, and (ii) securities of firms that are energy-intensive, which might be affected indirectly via an increase in energy costs. Between them, these two tiers of assets account for around a third of global equity and fixed-income assets.
Commodity Price Volatility --
Risk Implications for Investors
Timing: Near-Term Mid-Term Long-Term Severity: High Low Impact: Focused Diffuse
Commodities futures investors, in particular, cannot ignore the influences meterological events have on their investments. As a result, these investors should be particularly aware of the potential consequences of climate change. Although weather related effects will certainly increase as global temperatures increase, we are already seeing growing evidence of how these events will affect comodities prices. The recent U.S. drought in the Midwest reduced corn and soybean output. That led to increases in the cost of cattle feed. In addition, the drought's affect on grazing land forced herd reductions. The combination led to far higher beef prices. Similarly, Russia's 2010 heat wave led to U.S. $15Bn in economic losses due to combined drought and wildfire effects on Russia's wheat crop. In 2014 droughts in Brazil, the Midwest, the Ukraine and Australia combined to sharply increase the prices of coffee, cocoa, wheat and other grains. As a result, the S&P GSCI agricultural and livestock index jumped almost 17 per cent. PWC recently examined a series of these commodities impacts [Note 1]:
Climate change is altering the complexity of weather risk, the interdependence of weather and other risks and the contagious impact a group of these risks can have on global commodities prices. Some regions may actually benefit and it appears likely that less developed countries in the tropical regions will see the greatest negative impacts.
A recent paper: Climate Change and Agricultural Commodities [Note 2], summarized the overall risk as follows: "A greater frequency of extreme events, heat stress, droughts and floods, will increasingly have negative impacts on crop yields. In particular, water scarcity and the timing of water availability will increasingly constrain production. Climate change will increase pest and disease outbreaks thus negatively affecting food production. Rising carbon dioxide (CO2) levels will also have effects, both detrimental and beneficial, on crop yields. The ability of farmers and rural societies to adapt to these changes is crucial to maintaining an adequate global food supply. While demand is likely to increase, due to rising global population size primarily, climate change will challenge agricultural production and food security (locality of production, supply, volume, quality). By 2080, agriculture output in LDCs may decline by 20% due to climate change and yields could decrease by 15% on average."
For 2016, the severity of the El Niño effect may cause ripple effects for both farmers and traders. Likely areas to be impacted include India, Australia (wheat), west Africa and southeastern Asia (Cocoa and coffee).
1. Business-not-as-usual: Tackling the impact of climate change on supply chain risk http://www.pwc.com/gx/en/services/advisory/consulting/risk/resilience/publications/business-not-as-usual.html
2. Climate Change and Agricultural Commodities, http://www.cabi.org/Uploads/CABI/expertise/climate-change-and-agricultural-commodities-working-paper.pdf
3. Recent trends in world food commodity prices: costs and benefits, http://www.fao.org/docrep/014/i2330e/i2330e03.pdf
4. HEAT IN THE HEARTLAND: CLIMATE CHANGE AND ECONOMIC RISK IN THE MIDWEST; http://riskybusiness.org/uploads/files/RBP-Midwest-Report-WEB-1-22-15.pdf
5. CLIMATE RISKS TO CALIFORNIA AGRICULTURE; http://riskybusiness.org/reports/california-report/climate-risks-to-california-agriculture
Supply Chain Disruptions --
Risk Implications for Investors
Timing: Near-Term Mid-Term Long-Term Severity: High Low Impact: Focused Diffuse
Modern business depends on global supply chains. Therefore severe weather events, droughts, fires and floods that may occur thousands of miles away can have very real and near-term local economic effects. For the most part, however, companies and consumers at the other end of these global supply chains have seen little direct effects of climate change. In a few cases, costs have risen rapidly or companies have had to find alternate sources of supply, but generally there is very little coordinated business action on climate adaptation. A recent study by the Organisation for Economic Co-operation and Development (OECD) found that few companies had undertaken any formal assessment of the specific climate related risks they face and fewer still had taken any action to reduce those risks.
The Carbon Disclosure Project's 2014-2015 Supply Chain report (see Note 1) found supply chains in the US, China and Italy to be particularly vulnerable to climate change. In addition, it found that suppliers in India and Canada were not doing enough to manage climate change risks and that suppliers in Brazil have done the least to manage climate exposures. Interestingly, the CDP Report also found opportunities for high-return investment, particularly as a result of collaboration amongst global producers and their supply chain partners in China and India. CDP's 2012 survey found that 70 percent of the 2,500 responding companies identified climate change as a risk to their business.
A recent Ernst & Young Report on Supply Chain Risk (See Note 4) highlighted four key areas of supply chain optimization:
1. Take a holistic, lifecycle approach to identifying and implementing value creation opportunities, risk-mitigation actions and efficiency-related initiatives in supply chain optimization;
2. Embed climate change and sustainability as part of the supply chain risk assessment, including compliance, financial, reputational, strategic and physical/operational
3. Review processes for climate change and sustainability reporting needs
4. Monitor and assess the impact of existing or potential government regulations on the entirety of the supply chain
Notes:
1. Supply Chain Sustainability Revealed: A Country Comparison; https://www.cdp.net/CDPResults/CDP-Supply-Chain-Report-2015.pdf
2. CLIMATE CHANGE RISKS AND SUPPLY CHAIN RESPONSIBILITY; https://www.oxfam.org/sites/www.oxfam.org/files/dp-climate-change-risks-supply-chain-responsibility-27062012-en.pdf
3. Assessing and managing climate change risks in supply chains; http://climateuk.net/sites/default/files/Supply%20Chains.pdf
4. Five areas of highly charged risk for supply chain operations; http://www.ey.com/US/en/Services/Specialty-Services/Climate-Change-and-Sustainability-Services/Five-areas-of-highly-charged-risk-for-supply-chain-operations