The world is currently experiencing extreme weather events such as heatwaves, wildfires, and heavy rainfall. These events have devastating effects, leading to floods in northern China and wildfires in Canada, southern Europe, and Maui. Climate change, caused by human activities, is making these disasters more frequent and intense, resulting in loss of life and economic damage.
One significant concern is the possibility of a “climate Minsky moment,” where asset values suddenly correct as investors realize their unsustainability. Currently, businesses and investors focus more on decarbonization costs and risks rather than the physical effects of climate change. This skewed attention is evident in corporate disclosures in the US. Equities have not appropriately accounted for climate change risks, as studies by the IMF and others have shown.
The perceived remoteness of risks like sea level rise and the complexity of mapping the interactions between the economy and greenhouse gas emissions contribute to this lack of attention. However, efforts are being made to address this issue using vast computing power. For instance, Cambridge Econometrics and Ortec Finance recently conducted a study for Singapore’s GIC, a sovereign wealth fund concerned about climate risks. Their findings showed that in a scenario involving ambitious decarbonization, the portfolio’s cumulative returns over 40 years were 10% lower than a baseline without climate change. In the worst-case scenario, where no effective transition occurs, cumulative returns dropped by nearly 40%.
Investors need to acknowledge the long-term climate risks and their potential impact on various sectors. Agriculture is especially vulnerable, with a significant percentage of staple crop production coming from at-risk areas. Climate change-induced disasters could jeopardize billions of dollars in annual production. Analysis of climate risks indicates potential sharp increases in commodity prices. For example, extreme weather events might raise palm oil prices by 12-18% and other food and commodity ingredients by 14-21% by 2050.
The impact of climate change on agriculture and water resources is unevenly distributed. Some crops have migrated to cooler climates, benefiting countries like Russia, making them top agricultural players. However, water shortages exacerbate food insecurity, as agriculture accounts for a significant portion of global freshwater consumption. Water scarcity is becoming a growing concern in Europe, affecting industries reliant on water resources, such as the chemical sector. Moody’s estimates that half of the chemical sector’s global assets are exposed to water stress.
Both too much and too little water pose risks to various industries. For instance, flood-prone areas in Asia host numerous computer and electronics factories. Preventive measures, like raising foundations, can reduce flood risks. Finding ways to mitigate flooding risks is crucial, considering that recently published research suggests that US residential properties exposed to flood risk are overvalued by billions of dollars.
The mounting risks from climate change have far-reaching implications. Moody’s assessment indicates that San Francisco is one of the areas most economically exposed to these risks, while Boise and Nashville appear safer. Such projections provide insights into future migration patterns, with significant consequences for real estate values and tax bases. Globally, millions of people are already being displaced by extreme weather events each year. By 2050, climate change could uproot as many as 1.2 billion people.
These climate risks are also reflected in sovereign bonds, as countries facing higher physical risks pay higher spreads for debt financing. The financial consequences of climate change could result in sovereign downgrades, with China and India among the most vulnerable.
Mitigating climate change damage requires investment in defenses, such as dykes for coastal cities. Spending $50 billion annually on flood defenses could significantly reduce expected losses in 2050. Regions with greater wealth have better chances of implementing adequate defenses. As a result, S&P recently upgraded Miami bonds based on their preparedness for rising sea levels.
Overall, it is essential for investors and businesses to recognize and address the long-term climate risks. Failure to do so can have devastating consequences not only for lives and economies but also for asset values and financial stability.
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